Asset Ratios and Expenditure Ratios The analyst would now examine, by reference to the tertiary level of ratios in the pyramid, which constituent elements within the two secondary ratios have contributed to their increase in year 2. We shall direct our attention to just four of these. Management should attempt to maintain a proper balance for a given sales between the amount of funds invested in fixed assets and the amount tied up in working capital. The fixed asset:turnover ratio measures the number of E of sales generated by each f invested in fixed assets, and is calculated by sales/fixed assets: Unless there is a good match between the activities of two different companies, cross-sectional analysis can give rise to misleading comparisons with this ratio: in any given industry, a vertically integrated company will have a much greater investment in fixed assets than one which simply buys in from outside. Furthermore, as we saw in chapter 12, there is an unfortunate tendency in historical cost accounts for this ratio (and therefore ultimately ROCE) to increase by default, merely because of the shrinkage in the investment base due to the effects of depreciation. Other problems of comparability notwithstanding, cross-sectional analysis will also be complicated by the fact that different companies have fixed assets of different ages, and therefore net book values (although productivity might provide a counterbalance of sorts). Let us now turn to measures of working capital utilization. The stock: turnover ratio indicates how quickly products are being converted into sales. Except when stocks are built up to avoid sharp price rises on the part of suppliers, companies would prefer to carry stocks at a level which will minimize financing, handling and storage costs, and the risk of deterioration and obsolence. Although the ratio has hitherto been calculated as sales/ stocks, as set out in the pyramid, this is not as satisfactory a measure as cost of sales/stocks; after all, stocks are valued at cost in the balance sheet, and not selling price. This alternative calculation has been facilitated by recent Companies Act requirements for listed and large companies to disclose cost of sales figures, and we are able to do this for CIMA: The denominator in our example has been taken to be closing stock. A more accurate measure might be average stock, but this can smooth out the effect of any dramatic change in year-end stock levels. A useful indicator of the effectiveness of a company's credit control pro-cedures, and therefore their contribution to the general level of asset utiliz-ation, is the debtors:turnover ratio, which can be calculated in two ways, Sales/Debtors or Sales/Debtors × 365 - the latter expressing closing debtors in terms of the number of days sales they represent: In general terms, unless the company has recently adopted a more generous credit policy, to tempt customers away from more stringent competitors, there is no reason to expect an increase in sales to be accompanied by a reduction in the ratio (or an increase in the number of days' sales in debtors). Alter-natively, an increase in the ratio would not necessarily be cause for congratulation if it resulted from a desperate need for cash, which had led the company either to offer huge discounts for quicker payment, or to put undue pressure on customers to the potential detriment of future business. Obviously, the term 'debtors' refers to credit sales; the numerator should therefore be limited to credit sales. If a company has cash as well as credit sales, their relative proportions are unlikely to be revealed by the accounts, and the higher the proportion of cash sales, the less useful the ratio becomes to an outsider. The recent statutory provision of cost of sales figures, referred to above, has also enabled a more sensible creditors turnover than that shown in the pyramid to be calculated, namely cost of sales/creditors. This can also be expressed in the alternative form of number of days' sales, as we saw with debtors. The figures for CIMA are This is not entirely satisfactory, however, as creditors refer to purchases rather than to the cost of goods actually sold, but the problem can be easily overcome by adjusting the cost of sales numerator to take account of the movement in stocks over the year. Such a refinement might be considered unnecessary if the user is seeking merely to identify trends that will help to predict potential liquidity problems as well as explain part of the change in the secondary asset turnover ratio.