Efficiency Ratios

Efficiency Ratios (Activity)

  • Provides management perspective
  • How effective are the operations of the firm?
  • How effective is the company at using and controlling its assets?
  • How actively are the firm’s assets being deployed?
  • These figures are useful for credit, marketing and investment purposes

Collection Period (days) = Accounts receivable/sales x 365

-Indicates the average time period for which receivables are outstanding.

-How quickly customers are paying their bills?

-Generally, where most sales are for credit, any collection period more than one-third over normal selling terms is indicative of some slow-turning receivables.

-Example, 40.0 for 30-day term is bad

-Example, 32.8 for 30-day term is good

Sales to Inventory (Inventory Turnover) = Annual Net Sales/Inventory 

-Indicates the rapidity at which merchandise is being moved and the effect on the flow of funds into the business.

-This figure varies industry to industry, must be compared with competitors in the industry.

-Low figures are big problems

-High figures are good

-Note: Extremely high figures compared to industry norms might reflect in loss of sales due to insufficient merchandise.

Asset to Sales (%) = (Total Assets/Net Sales) x 100 

-This ratio indicates whether a company is handling too high a volume of sales in relation to investments.

-This figure varies widely from industry to industry, must be compared to industry norms.

– Abnormally Low % can indicate over-trading which can lead to financial difficulty. 

-Extremely High % can indicate overly conservative sales efforts or poor sales management.

Accounts Payable to Sales (days) = Accounts Payable/Annual Net Sales x 365

-This ratio measures the speed with which a company pays vendors relative to sales. 

-Numbers higher than typical industry ratios suggest that the company is using suppliers to float operations.

-This ratio is especially important to short-term creditors since a high percentage could indicate potential problems in paying vendors.

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