Operating Performance

A company's operating performance refers to its ability to direct assets and other resources toward executing business activities, such as manufacturing goods or providing services. The goal is to generate sales and increase profitability through the efficient use of these resources. Investors, creditors, and other stakeholders mainly use such insights to analyze the company's managerial competency in handling its business operations efficiently.

It enables the companies to devise internal strategies and operational changes to achieve optimal performance. Moreover, it serves as a tool for external parties to gauge a firm's future potential. In general, the operating performance ratios are also termed as the activity ratios that consider the items on the asset side of a company's balance sheet for measuring its overall efficiency. A business that generates high sales from its available resources and assets is considered more reliable and growth-oriented. In contrast, a business that struggles to generate sufficient revenue to become profitable is seen as less stable and less likely to grow.

The operating performance ratios are the key performance indicators (KPIs) that facilitate the measurement of a company's operating efficiency. These are:

1. Fixed Assets Turnover Ratio: This measure gauges a business's efficiency in using its fixed assets to generate sales. It is determined as net sales divided by the average net fixed assets.
2. Total Asset Turnover Ratio: Similar to the fixed asset turnover ratio, this metric identifies the business's ability to employ its overall assets for revenue generation. It is measured by dividing the total assets from the net sales generated in a given period.
3. Inventory Turnover Ratio: This turnover ratio analyzes the number of times a business can convert its inventory into sales during a given period. It is evaluated as total sales divided by the average inventory in a certain period.
4. Account Receivable Turnover: The debtor turnover ratio measures the company's ability to recover the debts on credit sales. It is determined as net credit sales divided by the average accounts receivable.
5. Days Sales Outstanding: This metric measures the number of days a firm takes to collect the dues on credit sales. It is computed as 365 days divided by the accounts receivable turnover ratio.
6. Sales Per Employee Ratio: It is the average sales generated by a company when allocated on each employee basis. It is evaluated by dividing the total number of employees from its net sales.
7. Accounts Payable Turnover: The creditor's turnover ratio measures the company's competency in settling credit payable accounts. It is calculated as net credit sales divided by average accounts payable.
8. Days Payable Outstanding: The number of days the company takes to clear the outstanding payments on credit purchases. It is determined as 365 days divided by the accounts payable turnover ratio.
9. Cash Conversion Cycle: This cycle measures a business's efficiency in transforming its raw material (bought on credit) into finished inventory, then sales and cash. It is calculated by deducting the days payable outstanding from the operating cycle.
10. Operating Cycle: It is the sum of the day's outstanding inventory and the day's outstanding sales. Thus, it determines management's operating efficiency and effectiveness.
11. Working Capital Turnover Ratio: The firm can generate sales on each dollar spent as working capital during the given period. It is evaluated as net sales divided by the average working capital.

Let us consider the following examples to understand the concept better:

Example #1

Suppose the information in the financial statements of PQR Ltd., as of the year ending on December 31, 2023, are as follows:

Net Sales = $7,48,000

Average Net Fixed Assets = $15,50,100

Total Assets = $21,10,870

Solution:

Fixed Assets Turnover Ratio = Net Sales / Average Net Fixed Assets = $7,48,000 / $15,50,100 = 0.48

Total Assets Turnover Ratio = Net Sales / Total Assets = $7,48,000 / $21,10,870 = 0.35

Thus, PQR Ltd. is efficient to employ its fixed assets and total assets to develop sales. Its fixed assets turnover ratio determines that it has already generated sales equivalent to 48% of its fixed asset investment during the period. The total assets turnover ratio is also impressive at 0.35 or 35%.

Example #2

Pan-American Life Insurance Group (PALIG) has published its financial performance for the year 2023. Its reports indicate a 7% growth in operating revenue, making it $1.31 billion, and a 5% rise in total premiums, amounting to $1.55 billion. PALIG's pre-tax operating income increased to $77.2 million, i.e., 14%, while the net income surged by 240%, rising to $63.7 million, because of a higher net investment income and a higher morbidity or mortality rate after the COVID-19. 

The company's GAAP equity was approximately $1.33 billion, after excluding its accumulated other comprehensive income (AOCI). Moreover, PALIG secured "A" ratings from both AM Best and Fitch Ratings. The CEO, José S. Suquet, acknowledged the company's success as a result of its continuous adaptation to various challenges and its acquisition of Encova Life at the beginning of 2024, which intended to increase the company's U.S. market footprint. The company targets the improvement of its operating performance for further success in 2024.

The management often gauges this concept in business management to ensure success in the long run. It is essential for the following reasons: 

1. Enhances Productivity and Profitability: It can help the company use its resources optimally for maximum output and productivity. Higher production ensures better profitability in the long run.
2. Greater Employee Satisfaction: It is crucial to achieve employee satisfaction by developing means for their training and development, ensuring a streamlined process, and providing avenues for individual growth.
3. Better Quality and Efficiency: Management studies these ratios to limit errors and defects in business operations, thereby achieving greater efficiency in processes and the production of improved-quality goods or services.
4. Minimizes Cost: Operational efficiency ensures optimal resource utilization, finds discrepancies in operations, and standardizes the process, helping management reduce operational costs.
5. Informed Decision-Making: These insights are critical for the business to make decisions based on the analysis and promote growth in the long run.