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April 19th 2019

Understanding efficiency ratios

Efficiency ratios measure a company’s ability to manage its assets and liabilities effectively.

Efficiency ratios can be used by any small business to compare current performance against their own historic position, or against competitors or industry benchmarks.

Asset turnover ratio

The asset turnover ratio is used to assess how good a business is at turning its assets into sales. It is calculated by dividing total sales by capital employed (equity plus long term debt).

The more efficient the business is at generating sales, the higher the ratio of turnover to assets.

Stock turnover ratio

The stock turnover ratio can help to determine how quickly a business turns its stock into sales.

Stock turnover is calculated by dividing the cost of goods sold by the average amount of stock held. Increases in the ratio over time may suggest that a business is turning round its stock more quickly; a deterioration in the ratio over time may indicate problems with overstocking or obsolete stock.

Stock days is a related ratio that tells us how many days on average it takes for a business to turn stock into sales, and is calculated (on an annual basis) as (stock / cost of goods sold) x 365.

Debtor turnover ratio

The debtor turnover ratio helps us measure how good a business is at getting paid for the sales that it makes.

The ratio is calculated by dividing sales by trade debtors. Increases in the ratio may suggest the business’s cash collection is improving; decreases in the ratio may suggest the opposite.

Debtor days is a related ratio that tells us how many days on average it takes for a business to turn credit sales into cash, and is calculated (on an annual basis) as (trade debtors / sales) x 365.

Contact us today to talk about how to improve financial efficiency in your business.

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