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Efficiency ratio analysis 3.6 (Stock (inventory) turnover (How to improve,…
Efficiency ratio analysis 3.6
Gearing ratio
How to improve
Sell assets and repay loans = assets may be more profitable in the future or currently
Sell shares or purchase additional capital (increase capital employed not loans) = Loans will be repaid but shares may not be re-bought. Permanent capital may dilute the ownership or control share holders have in the business
Keep retained profit levels as high as possible to increase capital employed but not loans = Takes long to reduce gearing ratio and cutting dividends may have a negative impact on share prices
A result of over 50% suggests a highly geared business as half of the finance is from long-term loans
The higher the borrowing the more interest to be paid - the case when profits are low and and interest rates are high.
A low gearing ratio shows a 'safe' and manageable business strategy but also suggest lack of investment from management in the business.
The higher the number = the greater the reliance, the more highly geared the business is on long-term loans.
Measures the degree to which the capital of the business financed from long-term loans.
Debtor days
Measures the avg. amount of time the business takes to receive payments for good bought on credit = the debtors.
The shorter the ratio, the better the business is at recovering debt and controlling its working capital
The final result are the 'days' it takes
There is no better or worse result - it varies from the business type and industry
Customers will be attracted to businesses allowing longer debtor days.
How to improve
Sell only to customers paying in cash - This would reduce sales and customer variance as there would only be one type of customer to sell to.
Ask debtors to pay faster - this may upset some debtors and reduce sales to customer who expect long credit terms.
Use debt factoring by selling debtors' invoices to factoring company's for cash = this will reduce bad debts but also cause a bad image on the business from customers. the profit margins will also fall as the factoring business will only purchase the invoice at a discount (lower than og price)
Creditor days
How to improve
Delay payment to suppliers = suppliers may object to not being paid promptly and may offer less discount and less support in urgent times (fast deliveries etc.)
Ask suppliers for extended credit terms = come may be unwilling and insist on strict credit terms
Only purchase from suppliers with extended credit terms = Limit the choice of suppliers and is unlikely to help build a long, strong relationship with the supplier.
New businesses may not be offered any credit by suppliers.
The higher the result (in days) the longer the business takes to repay suppliers
Measures how quickly a business pays its suppliers in a year
Stock (inventory) turnover
The lower the amount of holding inventory costs the better
The HIGHER the inventory turnover ratio the lower the capital tied up to inventory.
The ratio measures the amount of times inventory is brought into the business and then resold.
The higher the number the more efficient the managers are in selling the inventories fast. The JIT system gives a high inventory turnover
The 'normal' result depends on the industry.
How to improve
Reduce inventories of finished goods - Offering consumers less choice may reduce sales. If revenue falls the ratio will NOT improve
Reduce inventories of raw materials - Unless this is well done it could lead to production hold-ups and delays (customers may not wait for products to be produced)
Introduce a JIT system - Requires investment in IT, reliable suppliers, flexible production, an adapted workforce etc.
Inventory:
A complete list of items property, goods etc.