Growth is measured in progress. Identifying how a team, player, or individual is performing in a specific area and comparing it to previous measurements is often how growth is determined. Although past performance is not a guarantee for future results, it can help us understand how much growth has occurred. This process of benchmarking is important not only in sports, but also in the business world.
Taking the time to analyze performance in key areas offers insight into a company’s strengths and areas of improvement. One way that manufacturing companies can assess their situation is through financial ratios. These ratios provide insight into virtually every aspect of a company’s performance, including sales, operational effectiveness, debt management, and profitability. To help clients, prospects, and others understand the benefit to manufacturing companies, Selden Fox has provided a summary of the key manufacturing ratios below.
Return on Net Assets Ratio
This ratio measures how effectively a manufacturing company uses its assets, machinery, and equipment to produce revenue. Since industry companies rely heavily on assets to provide revenue, this is an important ratio to monitor. It is calculated by dividing net income by the sum of fixed assets plus net working capital. The higher this ratio is the better because it means the company is using its working capital and net assets more effectively to make money.
Inventory Turnover Ratio
This ratio measures the effectiveness of a company’s manufacturing process by determining how efficiently it is using its inventory. It is calculated by dividing the cost of goods sold by the average inventory balance. It is ideal for the number to be as low as possible; otherwise it indicates the company is not effectively managing its inventory.
Unit Contribution Margin Ratio
This ratio measures what percentage of revenue is needed to cover fixed costs and is used to determine the financial vitality of a company. To calculate the ratio, take the difference between total revenue and total variable costs and divide it by total revenue. A higher value is preferred because it indicates a company has an easier time covering fixed costs.
Revenue per Employee Ratio
This ratio measures the amount of revenue that a company makes per employee. It is calculated by dividing net revenue by total number of employees. A higher number is preferred because it demonstrates a company is more effectively using technology to produce a product. If a company with 100 employees and 50 employees achieve the same revenue per employee ratio, then it means the smaller company has found a process that allows them to earn more with a smaller staff.
Maintenance Costs to Total Expenses
Machinery is a core component of every manufacturing process. Companies rely on these machines to transform their inventory into a finished product for sale and shipment. An important measurement of the sustainability of long-term operations can be gleaned by comparing repair and maintenance costs to total expenses. When there is a low proportion of repair costs, either the company has machinery that doesn’t need a lot of repair, or it has elected to replace old equipment with new equipment. This ratio reveals management’s approach to new equipment purchasing and adoption of technology.
There are dozens of ratios that companies can use to assess their financial and operational health. The ones outlined above are typically utilized by manufacturing companies for benchmarking and to assess performance. If you have questions about financial ratios, or need assistance with a manufacturing accounting, tax, or audit issue, Selden Fox can help. For additional information please call us at 630.954.1400 or click here to contact us.