Many useful gauges of operations can be calculated from data reported in the financial statements. For example, you can determine the average number of days it takes to collect on customer accounts, the average number of days to pay vendors, and how much of the operation is effectively being financed with payment terms extended by vendors.
Accounts Receivable Turnover = Total Credit Sales / Average Accounts Receivable
This tells you the average duration of accounts receivable for credit sales to customers. This in turn can be expressed in terms of the collection period, as follows:
Average Collection Period = Days in Year / Accounts Receivable Turnover
or
Days to Collect = Trade Accounts Receivable / Credit Sales x 365
A similar calculation can be made on the liabilities side, with accounts payable to vendors:
Days to Pay = Trade Accounts Payable / Purchases x 365
To determine how much of a company’s accounts receivable and inventory are effectively being financed by the credit extended to the company by its vendors:
Financing of Trade Accounts Receivable in terms of Trade Accounts Payable = Trade Accounts Payable / Trade Accounts Receivable
Financing of Inventory in terms of Trade Accounts Payable = Trade Accounts Payable / Inventory
Effectively managing the credit extended by vendors can help a company’s cash flow and therefore its liquidity and solvency.
From data reported on the income statement, various relationships can be calculated between different expenses and revenues, or a certain type of expense as a percentage of total expenses.
Labor Cost Percentage = Payroll and Related Expenses / Total Revenue or Total Expenses
Interest Expense Percentage = Interest Expense / Total Revenue or Total Expenses
These types of ratios or percentages can be calculated for any item on the income statement. Which accounts are more important will depend on the nature of the business. For example, some operations are more labor intensive and some are more capital intensive. In a labor intensive operation, the percentage that employee-related expenses, including wages, salaries and benefits, represent in terms of total operating expense is relevant. In a capital intensive operation, repairs and maintenance may take on more importance.