3.6 Efficiency ratio

Question 1

Ratio analysis

Answer 1

A financial analysis tool used in the interpretation and assessment of an organizations financial accounts.

Question 2

Efficiency ratios

Answer 2

• inventory/stock turnover
• debtor days
• creditor days
• gearing ratio

Question 3

the stock turnover ratio (inventory turnover ratio)

Answer 3

An efficiency ratio that measures number of days it takes a business to sell its stock (inventory) / alternatively - shows a number of times during any given period of time that the business needs to restock or replace its inventory.

Question 4

Stock turnover ratio (number of times) - formula

Answer 4

cost of goods sold / average stock

Question 5

Stock turnover ratio (number of days) - formula

Answer 5

average stock / cost of good sold x 365

Question 6

How to improve the stock turnover ratio?

Answer 6

• getting rid of obsolete (outdated) inventory in order to reduce the firm’s stock levels
  -supplying a narrower range of products (simplifying the amount of stocks that the firm needs to be hold and control)
  -just-in-time (JIT) stock control system - the firm does not need to hold any stocks as these are ordered and delivered when needed

Question 7

Debtor days ratio

Answer 7

Ratio that measures the average number of days an organization takes to collect debts from its costumers, it measures the average debt collection period for a business.

Question 8

Debtor days ratio (number of days) - formula

Answer 8

debtors/ total sales revenue x 365

Question 9

How to improve debtor days ratio?

Answer 9

-creating incentives for costumers to pay by cash rather than credit
-shortening the credit period given to costumers
-using stricter criteria for those wanting to purchase products using trade credit

Question 10

credit days ratio

Answer 10

Efficiency ratio that measures the average number of days an organization takes to repay its creditors, it calculates the length of time it takes a business, on average, to pay its suppliers for items that have been bought on credit.

Question 11

Credit days ratio (number of days)

Answer 11

creditors/ cost of goods x 365

Question 12

How to improve credit days ratio?

Answer 12

-negotiating an extended credit period with the firm’s suppliers
-looking for different suppliers who offer preferential trade credit agreements
-using cash to pay for inventories instead of relying on trade credit

Question 13

Gearing ratio

Answer 13

An efficiency ratio that measures the extend to which an organization is financed by external sources of finance, it is loan capital expressed as a percentage of the firms total capital employed.

Question 14

Gearing ratio - formula

Answer 14

loan capital / capital employed x 100

Question 15

How to improve gearing ratio?

Answer 15

-paying off some of the firm’s long term liabilities (loan capital)
-enhancing the firm’s working capital (liquidity position) by improving its stock control
-trying to use or rely more on internal sources of finance