Comparative ratios for the retail sector

Written by catherine capozzi
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Comparative ratios for the retail sector
Investors can study ratios to measure collections and inventory turnover. (Jupiterimages/ Images)

Ratios provide a quick snapshot of a company's performance. These measurements can also provide a telling picture of the company's health when juxtaposed with the industry average. However, some ratios are more appropriate for certain industries than others. William Hettinger, author of "Finance Without Fear" explains a return on assets ratio, for instance, will be an unreliable gauge for investors. This is because its value is skewed based on whether or not the shop owns or rents its building. Some ratios, however, accurately encapsulate the retail industry's business hurdles.

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Current ratio

The current ratio measures a company's ability to fulfil its debt obligations in the short term. This is measured by dividing current assets by current liabilities. In comparison to a durable goods business with expensive machinery, the current ratio of a retail business is much lower. Sheeba Kapil, author of "Financial Management" explains the current ratio for the retail industry is low because of the tendency to sell in cash and buy with credit.

Inventory turnover

Inventory turnover illuminates how well retailers manage stocks of clothes, electronics or other goods. This ratio also provides insight into how well the company sells items. To calculate the inventory ratio, the cost of goods sold is divided by average inventory. Businesses maintain a fine balance between having too much inventory remaining and not enough. If too much inventory remains, the company didn't gauge consumer demand effectively. Consequently, the company must sell the remaining goods at a steep discount. On the other hand, not having enough inventory causes shortages. How quickly the business goes through its inventory is also revealing. A high inventory turnover reflected by constant reorders isn't cost-efficient based on paying for shipping costs. Not going through inventory fast enough means the company could be paying too much in storage costs. Thus, comparing the turnover ratio with competitors gives the company insights into potential weaknesses.

Receivables turnover

Because the retail industry operates on consumer credit, collections on receivables are a critical component. Financial investors can assess how well a business accomplishes this task by analysing the receivables turnover ratio. To get the value, investors divide the annual sales from credit by the company's accounts receivable. Successful shops collect the outstanding debt from customers quickly, which improves the company's cash position.

Operating cash flow ratio

The operating cash flow ratio assesses how well the business is managing cash from sales in relation to its revenue. The OCF ratio is calculated by dividing the company's operating cash flow with its revenue or net sales. A shop should have a positive number, which indicates the cash flow improves with the sales of its goods. If this is not the case, it means the company is not selling enough goods or is acquiring too much debt.

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