How to Apply Key Ratios from the Profit & Loss Statement

Key Ratios of P&L Statements 

Every investor or trader aims for successful investments, but reaching that point requires methodical planning. What you've learned so far provides a strong foundation in analysing a company’s performance but to truly sharpen your decision-making, you need tools that quantify performance effectively. 

This section, and the ones that follow, introduces you to financial ratios, especially those derived from the Profit and Loss (P&L) Statement. These ratios help interpret a company’s financial standing and operational efficiency. 

Let’s begin with two essential categories: 

• Asset Efficiency Ratios 

• Collection Efficiency Ratios 

Asset Efficiency Ratios 

1. Total Asset Turnover Ratio 

This ratio reveals how efficiently a company uses its total assets to generate sales. 

Formula: 
Total Asset Turnover = Net Sales / Average Total Assets 

Insights from m.Stock Data: 

Observation: 
There’s a noticeable decline in the ratio post-2019, which may point to recent asset additions. This is typical in manufacturing companies expanding capacity, and improvements may be visible in future revenue growth. 

2. Net Fixed Asset Turnover 

It assesses how well the company is generating revenue from its fixed assets. 

Formula: 
Net Fixed Asset Turnover = Net Sales / Avg Fixed Assets 

Observation: 
A decline in the ratio since 2019 suggests underutilization of fixed assets or capacity build-up for future growth. 

Collection Efficiency Ratios 

3. Receivables Turnover Ratio 

Shows how often receivables are converted into cash during the year. 

Formula: 
Receivables Turnover = Net Sales / Avg Receivables 

Receivable Days Formula: 
Receivable Days = 365 / Receivables Turnover 

Observation: 
The turnover rate has decreased while the number of receivable days has increased. This signals a slower collection process , something to monitor closely. 

4. Inventory Turnover Ratio 

Evaluates how frequently inventory is sold and replenished. 

Formula: 
Inventory Turnover = Cost of Goods Sold (COGS) / Avg Inventory 

Inventory Days Formula: 
Inventory Days = 365 / Inventory Turnover 

Observation: 
The turnover remains stable around 6 times per year, indicating consistent demand and inventory management. 

5. Payables Turnover Ratio 

Measures how quickly the company settles dues to suppliers. 

Formula: 
Payables Turnover = COGS / Avg Payables 

Payable Days Formula: 
Payable Days = 365 / Payables Turnover 

Observation: 
An increase in payable days could suggest better credit terms, but prolonged periods can harm vendor relationships. 

Note: In some cases, net credit purchases is used in the numerator to calculate Payables Turnover instead of cost of goods sold. 

Working Capital Cycle 

This cycle reflects how long a company takes to convert its working capital into revenue. 

Formula: 
Working Capital Cycle = (Receivable Days + Inventory Days) - Payable Days 

Observation: 
A negative working capital cycle (like in Mar-21) indicates the company receives cash from customers before it pays suppliers , indicating a strong liquidity position. 

Key Takeaways 

• P&L ratios offer crucial insights into a company's operational health. 

• Efficient use of assets and streamlined collection/payment cycles enhance cash flow. 

• Regularly reviewing these ratios can help assess whether a stock aligns with your investment strategy. 

By mastering these tools and tracking these metrics using platforms like m.Stock, investors can make more informed, data-driven decisions.