Efficiency ratios
Asset turnover
Revenue / net assets
Revenue / capital employed
Expressed as the number of times net assets are turned over and expresses the ability of a business to generate revenue from capital employed
A high number relative to like companies in the same industry might indicate more investment is need whilst a low number indicates the business it not utilising its assets efficiently
Non current asset turnover
A measurement of how effective a company is at germinating revenue form non current assets at its disposal
Revenue / non current assets
Particularly relevant for manufacturing companies and others that have substantial investment in non current assets
A fall in revenue is likely to result in a fall in the efficiency ratio (unless non current assets also fall in value due to depreciation / impairment)
If revenue does not change from one year to the next and yet the ratio falls, it may indicate a fall in efficiency or that the company is over invested in non current assets which are failing to generate sufficient returns. It may also be as a result of the company having upgraded its plant and equipment which may result in higher revenue being generated in future years
Inventory turnover
Measures how efficient an entity is at converting inventory to revenues and show how often inventory is turned over or used during the period under review
A quick rate indicates that inventory is tightly controlled or that cash may not be available to place larger inventory orders
A low rate may be a result of poor sales volumes or a relatively large order of inventory having previously been placed
Long turnover periods might mean excessive stocks leading to higher storage costs and increased risk of being left with obsolete stock which may never be sold
Low stock turnover implies either a downturn in trading or overcapitalisation which can lead to a lower return on investment
Cost of sales / inventory
The inventory days formula shows the number of days it takes to turn over the inventory
inventory / cost of sales x365
The average inventory figure is used in the calculation. This is calculated as
opening inventory + closing inventory / 2
The manufacturing inventory controls inventory turnover tingly by using use in time procurement methods. This minimises stockholding which reduces inventory costs and improves the quick ratio
Revenue to net working capital
Shows the amount of net current assets required to generate revenue and helps a business control its cash levels
If a company uses long term capital to fund short term obligations it should expect lower investment returns
A measure of how efficiently working capital is turned over
Revenue / net working capital x100
A high ratio indicates the company has a strong ability to use working capital efficiently to maintain sales and low ratio indicates inefficiency and overcapitalisation
Debtor days
A measure of the average time it takes debtors to pay for goods they have received on credit
An increase in debtor days is a sign that the quality of the debtors is decreasing and could if not addressed lead to a business having cash flow difficulties
In a financial services company debtors days which exceed 90 days usually have to be discounted for the purposes of short term liquidity calculations as it becomes increasingly less certain the debtors will pay in full in a timely manner
In retail clothing business the average debtor payment period is often significantly shorter and credit terms of no more than 30 days are not unusual
Te lower the debtor days the better the cash position for the company
A business with a tightly run credit control department will regularly monitor the average debtor payment period and look for movements in the trend so that increases in debtor days are effectively managed in a timely manner
Trade receivables / revenue x365
Creditor days
This measures the average time it takes a business to pay its creditor
Trade payables / purchases x365
If the ratio is over 90 days in say the financial services industry it could mean that the business is struggling to generate sufficient cash to settle its invoices in a timely manner. It could also imply unethical practice eg a major supermarket chain internationally delaying payment to suppliers who are dependent on the supermarket for business