Earnings Basket: Three Indicators to Consider When Analyzing Operating Capability

It is difficult for ordinary investors to have direct contact with a company's management team. So, how can we evaluate a company's management level?

The answer lies in analyzing its operating capability.

Companies with strong operating capabilities usually have lower business risks, higher profitability, and greater competitiveness, leading to higher potential investment returns.

Here are three commom indicators for measuring a company's operating capability.

1、Total Asset Turnover Ratio

The Total Asset Turnover ratio measures a company's efficiency in using all of its assets to produce sales. To calculate the ratio, divide the net sales by the average total assets [Average Total Assets = (Total Assets at Beginning of Period + Total Assets at End of Period) / 2]. A higher-than-1 total asset turnover ratio may indicate that a company is more efficient and competitive; however, it's important to note that the ratio varies across industries. If a company maintains a higher total asset turnover ratio than the industry average over time, it may suggest that the management team is effectively utilizing the company's assets to generate revenue.

2、Inventory Turnover Ratio

The inventory turnover ratio measures how well a company manages its inventory and provides insight into the strength of its sales. A higher-than-10 ratio may indicate strong sales, while a lower-than-average ratio may suggest issues with sales. The ratio is calculated by dividing the cost of goods sold by the average inventory value [Average Inventory value = (Value of Inventory at Beginning of Period + Value of Inventory at End of Period) / 2]. A low inventory turnover ratio is especially concerning for industries such as retail, fashion, and apparel where products can easily depreciate in value.

3、Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio is an important indicator used to evaluate a company's ability to collect its debts. It is calculated by dividing net credit sales by the average accounts receivable during a given period.

A higher-than-10 accounts receivable turnover ratio may indicate a stronger bargaining power over clients, while a lower-than-average ratio may suggest sales issues or difficulties in collecting payments. It's worth noting that some receivables might become bad debt and be written off, potentially impacting a company's financial health.

If you find this helpful, please like and follow Moomoo Learn for more useful content!