In the retail industry, key financial ratios help with the management of selling operations. Investors analyze such financial ratios to determine the long-term security, short-term effectivity, and profitability of a retail company.
Financial ratios also aid in revealing how successfully a retail company is selling inventory, pricing its products, and operating its business.
The current ratio is calculated by dividing the company’s current assets by the current liabilities it has. This financial metric measures the ability of a company to pay off its short-term obligations.
When the current ratio is greater than one, it indicates that the company can cover its short-term debt with the most liquid assets it has.
And to an investor, the current ratio measures the liquidity and short-term stability of an organization during the potential seasonal fluctuations that are common in the retail industry.
The quick ratio is calculated by dividing the company’s cash and accounts receivable by its current liabilities.
This one is similar to the current ratio save for that the quick ratio is a more accurate measure of the immediate liquidity of the company.
If a company must liquidate its assets to pay its bills, the companies with a higher quick ratio need to sell only a few assets.
For the investor, the quick ratio offers insight into the stability of the immediate liquidity position of a company.
Gross Profit Margin
The gross profit margin refers to a profitability ratio that you calculate in two steps. First, you get the gross profit by subtracting a company’s cost of goods sold (COGS) from its net revenue. Then, you divide the gross profit by the net sales.
This gauge is especially useful to management as well as investors concerning the markup earned on products.
For the investor, higher gross profit margins are better since a piece of inventory generates more revenue when it is sold for a higher gross profit.
Since all items in a company are inventory items, the gross profit margin relates to every item in a retail store.
You calculate this measure by the dividing the net sales for a period by the inventory balance also for the same period. The inventory turnover gauges the efficiency of inventory management.
Retail companies have inventory on hand to secure and protect. At the same time, older inventory may turn obsolete.
Because of this, higher inventory turnover is favorable for the management as well as the investors. Meanwhile, a low inventory turnover means a company may be inefficiently holding too much inventory or not reaching sufficient sales.
On the flipside, a very high inventory turnover ratio can mean the company is efficiently ordering inventory but not receiving ordering discounts.
Return on Assets
Return on assets refers to measure of how well a company is using its assets in order to generate revenue.
This measure is usually important for a retail company, which depends on its inventory to generate sales. The financial ratio is calculated by dividing a company’s total earnings by its total assets.
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