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Efficiency ratios (Inventory turnover (Measures how efficient an entity is…
Efficiency ratios
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
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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
Debtor days
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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
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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
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Asset turnover
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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
Creditor days
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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