3.6 Efficiency ratio analysis

Question 1

What does the “Debtor Days Ratio” measure?

Answer 1

How efficient is the business in collecting money from its debtors

Question 2

How do you calculate the “Debtors Days Ratio”?

Answer 2

Debtor days ratio (number of days) = ( Debtors / Total sales revenue ) x 365

–> the lower the value of the debtor days ratio, the better it is for the firm
–> shows that the firm is efficient in getting debtors to pay on time

Question 3

What are some ways in which the business can improve the debtor days ratio?

Answer 3

• Creating incentives for customers to pay by cash rather than credit
  –> eg. giving discounts for paying w cash
• Shortening the credit period given to customers
  –> eg. reducing from 60 days to 30 days
• Install stricter criteria for those wanting to purchase products using trade credit
  –> eg. Business only gives trade credit to customers that have a track record of paying their invoices in a timely manner

Question 4

What does the “Creditors Days Ratio” measure?

Answer 4

An efficiency ratio that measures the average number of days an organization takes to repay its creditors.

Question 5

How do you calculate the “Creditors Days Ratio”?

Answer 5

Creditor days ratio (number of days) = ( Creditors / Cost of goods sold ) x 365

Question 6

What does the “Stock Turnover Ratio” measure?

Answer 6

An efficiency ratio that measures the number of days it takes a business to sell its stock (inventory).
eg. how quickly the stock is sold and has to be replenished

Question 7

How do you calculate the “Stock Turnover Ratio”?

Answer 7

Stock turnover ratio (number of days) = ( Average stock / Cost of goods sold ) x 365

Question 8

What does the “Gearing Ratio” measure?

Answer 8

Gearing ratio is an efficiency ratio that measures the extent to which an organisation is financed by external sources of finance.

Question 9

How do you calculate the “Gearing Ratio”?

Answer 9

Gearing ratio = ( Loan capital / Capital employed ) x 100