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.
Financial Freedom 101 