Our next set of metrics, we'll look at how efficient the corporation is using its assets. So efficiency measures. And then it will become clear how an inefficient use of the assets will impose risks on the corporation. Will impose risk on the performance of the firm. So we're going to look a little bit closer at whether we're doing more with less. We've got three sets of ratios in this context. The efficiency or also known as activity ratios capture the firm's ability to most effectively use its assets in generating revenue in creating profit. Our first metric here is total asset turnover. Total asset turnover is defined as net sales divided by total assets. Again, we have a flow variable, sales, measured from the profit and loss statement over the past financial year divided by a financial metric, which is measured from the balance sheet, the stock variable, and therefore we need to take the average of the two successive balance sheet statements. So the total asset turnover for Kellogg's in 2014 is measured as 0.95. That metric in itself is not all that indicative, but again, we can compare the 0.95 with the metric for 2013, for 2012, for 2011 and see whether there's any deterioration or improvement in the number of sales that Kellogg's is able to make out of its total asset base. A second set of metrics capturing activity or efficiency is inventory. How efficient is Kellogg's in dealing with its inventory? Inventory turnover is defined as the cost of goods sold divided by the average inventory. Once more, a flow variable from the profit and loss statement, cost of goods sold, divided by a stock variable from the balance sheet average inventory. We compute the inventory turnover and then through a slight adjustment to that metric we take the inventory turnover we just computed and we take that as the denominator in a simple division of 365 days in the year divided by the inventory turnover to measure in days how quickly that inventory is either produced or sold. So how quickly we're able, whether the firm is able, to move its inventory into sales. Of course the speed at which Kellogg's or any other corporation can move its inventory will depend on production technology. It will depend on perishability of the assets and a variety of inventory evaluation methods. So we need to do this taking account of the context again, there is a narrative that the financial analyst will pick up when it's interpreting these measures of inventory turnover. It's only meaningful to compare inventory turnover with other similar firms or over time. On it's own, it is not a particularly insightful metric. So the inventory turn over for Kellogg's in 2014 is 7.5. If we translate that into something which is a bit more intuitive, days in inventory, we find 48 days. So an item, on average, is in inventory for Kellogg's for 48 days. Is that fast enough? Is that improving over time? That depends on those circumstances that I've just described on the previous slide. And final set of efficiency and activity ratios is given by the credit and accounts receivable. How quickly is Kellogg's able to get payment for its sales? So whereas most firms would sell on credit, creating the balance sheet line item accounts receivable, it is a matter of liquidity, as we will see in the next video, of how quickly the corporation is really able to get payment within that grace period of credit to ensure that there's sufficient liquidity within the firm, which is so necessary as we just discussed, to be able to pay interest expenses on the liabilities. So accounts receivable turnover is defined as net sales, defined by average, again, stock variable from the balance sheet, accounts receivable. It should be compared once more with like firms, like Kraft. But the collection period is again, also the more intuitive of these connected ratios, so the average collection period in days is defined as 365 divided by this ratio you've just computed the accounts receivable turnover. So for Kellogg's in 2014, the accounts receivable turnover ratio is 10.8, which translates into an average collection period in days, of 34 days. Assuming that Kellogg's is giving credit for 90 days, that is not a bad outcome. That suggests that the average customer of Kellogg's is actually paying with a full 60 days left on the credit period. As a rule, this measure should not exceed the credit period, the credit terms that are given by corporations like Kellogg's by more than 10 days. If it does, then the corporation might start observing significant pressure on liquidity, which might have financial distress implications. So, here you have it. The full comparison for Kellogg's and Kraft of those in total five ratios that you can use to assess, that the analysts are using to assess the efficiency, with which Kellogg's and Kraft are using their scarce resources.
