Financial Guide for SMEs - SME Corporation Malaysia

Financial Guide for SMEsManagement RatiosManagement ratios monitor how effectively you aremanaging your working capital, that is, how quicklyyou are replacing your inventories, how often youare collecting debts outstanding from customers andhow often you are paying your suppliers. Thesecalculations provide an average that can be usedto improve business performance and measureyour business against the industry average (refer toChapter 5 for more details).HINTUse the number ofdays for inventory,debtors and creditorsto calculate the cashconversion rate foryour tradingactivitiesDays inventory = Inventory x 365Cost of goods soldThis ratio reveals how well your inventory is being managed. It is importantbecause it will indicate how fast inventory is being replaced. Usually, thehigher number of times the inventory can be turned in a given operating cycle,the greater the profi t.Days debtors = Accounts receivable x 365Net incomeThis ratio indicates how well the cash from customers is being collected -referred to as accounts receivable. If accounts receivable are excessivelyslow in being converted to cash, the liquidity of your business will be severelyaffected (accounts receivable is the total outstanding amount owed to you byyour customers).Days creditors = Accounts payable x 365Cost of goods soldThis ratio indicates how well accounts payable are being managed. Ifpayables are being paid on average before agreed payment terms or beforedebts are being collected, cash fl ow will be affected. If payments to suppliersare excessively slow, there is a possibility that relationship with thesupplier will be damaged.TIPComparing your management ratio calculations to businesses within thesame industry will provide you with comparative information that mayhighlight possible scope for improvement in your trading activities27Chapter 2-5 p22-65 Eng.indd 278/15/11 5:01:52 PM