Key Financial Ratios for Manufacturing Companies

A manufacturing company requires efficient use of inventory, equipment and personnel to develop its products. To gauge the appropriateness of operations and to determine how well the manufacturing process is going, a company uses the following financial ratios to evaluate its business. Additionally, these financial ratios are equally useful to an investor wishing to gain a deeper understanding of a manufacturing company.

The inventory turnover ratio measures the effectiveness of a company’s manufacturing process. It is measured by dividing the cost of goods sold by the average balance in inventory. An investor should maintain a watchful eye for a turnover ratio that is high, as a low calculation is an indicator that a manufacturing company is handling too much inventory. This places the manufacturing entity at a greater risk for inventory obsolescence or theft of company property.

A manufacturing company may utilize equipment or machinery during the production process of its goods. A critical measurement of the sustainability of long-term operations is comparing repair and maintenance costs in relation to total expenses. A low proportion of repair costs signals one of two things. First, a company has in place durable fixed assets that do not require as much ongoing maintenance. Second, a company may elect to simply replace equipment with newer, more reliable heavy machinery. In either case, an investor gains insight regarding management's long-term strategic planning in regards to implementing available technology.

A manufacturing company incurs numerous expenses while developing and manufacturing a product. Although the direct materials of the product are easily traceable, the numerous other factors and charges that go into a good may not be as easy to identify. Therefore, this financial metric divides the total manufacturing costs, not including direct materials, by the number of units produced. An investor can utilize this figure by determining how much overhead is required to produce a good and how efficient a company’s process is compared to other entities.

A manufacturing company incurs expenses while producing a product as well as indirect costs needed to operate the business. From an investor’s standpoint, it is more desirable to see a majority of costs directly tied to the product being made as opposed to other expenses, including supervisor salaries or building rent. Manufacturing costs to total expenses is a financial metric that measures this proportion. A higher calculated result indicates more expenses are attributable to costs directly needed to manufacture the product.

Dividing the total revenue of a manufacturing company by the number of employees generates the revenue earned per employee. An investor uses the calculation to determine the technological efficiency of an entity. For example, two manufacturing companies each earned $10 million in revenue. However, one manufacturing company has 50 employees, while the other has 20. Assuming the companies produce similar goods, the company with 50 employees may be operating inefficiently. Alternatively, the company with 20 employees is theoretically employing more efficient technologies with greater capabilities. To an investor, this metric is important, as the company with 20 employees is better financially leveraged in the long term.

The contribution margin ratio is calculated by taking the difference between total revenue and total variable costs and dividing this figure by total revenue. For example, products sold for $1,000 with $300 of variable costs have a contribution margin ratio of 70% (($1,000 - $300) / $1,000). The ratio measures what percentage of revenue is attributed to covering fixed costs. An investor can use this ratio to determine the security of a manufacturing company. A manufacturing company with a high contribution margin ratio has an easier time covering fixed costs and is a less risky company in which to invest.

A manufacturing company utilizes its assets — primarily its inventory and equipment — in producing revenue. For this reason, an important financial measurement is return on net assets. By dividing net income from a manufacturing plant by the net assets of the division, a manufacturing company can measure how successful parts of its business are in utilizing its assets to develop a profit for the company. An investor should use this ratio to determine the most efficient manufacturing companies.