3.6 Efficiency Ratio Analysis Flashcards
stock turnover ratio
aka inventory ratio
measure on number of times, on average, a company sells and replenishes its stock
rate at which a manufacturing business uses its stock of resources in a given time period
stock turnover formula (number of times)
cost of sales/ average stock
stock turnover formula (number of days)
(average stock/ cost of sales) * 365
average stock formula
(opening stock + closing stock) / 2
low inventory turnover ratio
slow sals due to poor quality or range of goods, inadequate promotion, overstocking etc.
can raise storage costs for the business
debtor days ratio
measure of the average number of days that it takes a business to collect its debts
debtor days formula
(debtors/ sales revenue) * 365
creditor days ratio
measure of the average number of days taken for a business to pay its debts
creditor days formula
(creditors/ cost of sales) * 365
longer creditor days…
better for business
longer debtor days…
worse for business
gearing ratio
measure of how much of a business’s capital employed is financed by long-term debt
higher gearing ratio
more of the business’s operations are funded by long-term debt
gearing ratio of 25%
low
gearing ratio 25-50%
normal
gearing ratio over 50%
high
gearing ratio formula
(non-current liabilities/ capital employed) * 100
capital employed formula
non-current liabilities + equity
strategies to improve stock turnover ratio
- supplying narrowe range of goods
- selling obsolete stock, stocking goods in high demand
- just-in-time stock control
benefits of a narrower range of goods
simplifies the stock, increases the control over stock and can reduce stock quantities
limitations of a narrower range of goods
simplifying the product portfolio and offering reduced choice to customers may negatively affect sales revenues if fewer items are sold as a result
benefits of selling obsolete stock, stocking goods in high demand
reducing unpopular stock items can reduce stocks.
selling goods in high demand will increase sales of stocks.
saves of storage costs.
limitations of selling obsolete stock, stocking goods in high demand
simplifying the product portfolio and offering reduced choice to customers may negatively affect sales revenues if fewer items are sold as a result
benefits of just-in-time stock control
stock could be ordered only when needed for the production process.
ensures there is no excess stock
limitations of just-in-time stock control
delays in supply chains can cause the business to run out of stock, reducing sales revenues and causing customer dissatisfaction
strategies to improve debtor days
- having customers pay in cash
- shortening the credit period
- improving credit control
- refusing to do business with customers who pay late
- threatening legal action or imposing a penalty
benefits of having customers pay in cash
business could offer discounts for cash payments, charge interest on credit payments or have a cash-only policy
–> reduce amount of withstanding purchases on credit
benefits of shortening the credit period
debtors pay sooner, so debtor days decrease
benefits of improving credit control
business could give trade credit only to customers with a record of paying on time
stricter criteria for buying on credit, reducing customers who buy on credit
benefits of refusing to do business with customers who pay late
stopping deliveries to customers who have not yet paid for the product should also bring faster payment, reducing debtor days
benefits of threatnening legal action or imposing a penalty
threaten legal action against customers who do not pay for delivered products
could charge interest on overdue amounts
limitations of strategies to improve debtor days
upset customers, decreasing sales revenue
business needs balance its own need to reduce debtors with its customers’ needs for flexible payment
strategies to improve (reduce) gearing ratio
- paying off liabilities
- increasing retained profit
- selling more shares
benefits of paying off liabilities
businesses can pay their long-term liabilities to reduce gearing ratio
limitations of paying off liabilities
less cash for daily operations, reducing sales revenue
benefits of increasing retained profit
cost minimisation and increasing revenue
increases value of denominator in the formula, thereby decreasing the gearing ratio
limitations of increasing retained profit
reducing dividends to shareholders, making them unhappy
benefits of selling more shares
increase the denominator and consequently decrease the gearing ratio
increase equity
limitations of selling more shares
dilute ownership of the company and reduce dividends to shareholders
insolvency
situation where business is unable to pay its debts
bankruptcy
situation where an insolvent business has to follow a legal process to settle its debts
conditions/ factors for insolvency
- debtor days too long
- loss of sales revenue
- increased costs
- legal action (ie sued)
