Key Financial Ratios of Manufacturing Companies

Manufacturing companies need to effectively use inventory, equipment, and personnel to develop their products. A company uses the following financial ratios to evaluate its business. These ratios can also be used to measure the adequacy of operations and determine the progress of the manufacturing process.

These financial ratios are also useful for investors who want to learn more about manufacturing companies.

Key points

  • Manufacturing companies need to effectively use their inventory, equipment, and personnel to develop their products.
  • Companies use multiple financial ratios to determine their actual efficiency.
  • Investors can use this information to determine the company’s investment value.
  • Manufacturing companies’ financial ratios include their inventory turnover, maintenance costs and expenditures, and income per employee.

Inventory turnover

The inventory turnover rate measures the effectiveness of a company’s manufacturing process. This ratio shows the number of times a company sells and replaces inventory in a certain period of time. It is measured by dividing the cost of sales by the average inventory balance.

Companies can use this ratio to make better decisions about pricing, manufacturing, marketing, and new inventory orders.

Investors should pay close attention to the high turnover rate, because a low turnover rate indicates that the manufacturing company has handled too much inventory. This puts the manufacturing entity at greater risk of obsolete inventory or theft of company property.

Total cost of maintenance

Manufacturing companies may use equipment or machinery in the production of their goods. A key measure of long-term operational sustainability is to compare repair and maintenance costs to total expenses.

The low percentage of maintenance costs indicates one of two things. First, the company has durable fixed assets that do not require much ongoing maintenance. Second, the company may choose to simply replace equipment with newer, more reliable heavy machinery. In either case, investors can gain insights into management’s long-term strategic plan for implementing available technologies.

Per capita income ratio

Divide the total revenue of the manufacturing company by the number of employees to get the revenue per employee. Investors use this calculation to determine the technical efficiency of the entity.

The employee turnover rate affects the income of each employee of the company.

For example, two manufacturing companies each earned $10 million in revenue. However, one manufacturing company has 50 employees, while the other has 20 employees. Assuming they produce similar products, a company with 50 employees may not be able to operate efficiently. Or, a company with 20 employees is theoretically adopting more efficient technology and greater capabilities.

For investors, this indicator is very important because, in the long run, companies with 20 employees have higher financial leverage.

Total manufacturing cost per unit minus materials

Manufacturing companies incur a lot of expenses when developing and manufacturing products. Although the direct material of the product is easy to trace, the many other factors and costs that enter the product may not be so easy to identify. Therefore, this financial indicator divides the total manufacturing cost (excluding direct materials) by the number of units produced. Investors can use this figure by determining the management costs required to produce the goods and the efficiency of the company’s processes compared to other entities.

Total cost of manufacturing

The manufacturing company incurs expenses and indirect costs required for operating the business when producing products. From an investor’s point of view, it is more desirable to see that most of the costs are directly related to production, rather than other expenses, including supervisor salaries or construction rents. The ratio of manufacturing costs to total expenses is a financial indicator to measure this ratio. Higher calculation results indicate that more expenses can be attributed to the cost directly required to manufacture the product.

Return on net assets

A manufacturing company uses its fixed assets (mainly inventory and equipment) to generate revenue. Therefore, an important financial measure is the return on net assets.

By dividing the net income of the manufacturing plant by the net assets of the division, a manufacturing company can measure the success of various parts of its business in using its assets to create profits for the company.

Investors should use this ratio to determine the most efficient manufacturing company.

The return on net assets also accounts for the company’s liabilities.

Unit contribution margin ratio

The contribution margin is calculated by dividing the difference between total revenue and total variable cost by total revenue.

For example, a product that sells for $1,000 and has a variable cost of $300 has a contribution margin of 70% (($1,000-$300) / $1,000). This ratio measures revenue as a percentage of fixed costs.

Investors can use this ratio to determine the safety of the manufacturing company. Manufacturing companies with high contribution margins are more likely to cover fixed costs and are less risky as an investment.

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