3.6 Efficiency Ratio Analysis

Question 1

stock turnover ratio

Answer 1

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

Question 2

stock turnover formula (number of times)

Answer 2

cost of sales/ average stock

Question 3

stock turnover formula (number of days)

Answer 3

(average stock/ cost of sales) * 365

Question 4

average stock formula

Answer 4

(opening stock + closing stock) / 2

Question 5

low inventory turnover ratio

Answer 5

slow sals due to poor quality or range of goods, inadequate promotion, overstocking etc.

can raise storage costs for the business

Question 6

debtor days ratio

Answer 6

measure of the average number of days that it takes a business to collect its debts

Question 7

debtor days formula

Answer 7

(debtors/ sales revenue) * 365

Question 8

creditor days ratio

Answer 8

measure of the average number of days taken for a business to pay its debts

Question 9

creditor days formula

Answer 9

(creditors/ cost of sales) * 365

Question 10

longer creditor days…

Answer 10

better for business

Question 11

longer debtor days…

Answer 11

worse for business

Question 12

gearing ratio

Answer 12

measure of how much of a business’s capital employed is financed by long-term debt

Question 13

higher gearing ratio

Answer 13

more of the business’s operations are funded by long-term debt

Question 14

gearing ratio of 25%

Answer 14

low

Question 15

gearing ratio 25-50%

Answer 15

normal

Question 16

gearing ratio over 50%

Answer 16

high

Question 17

gearing ratio formula

Answer 17

(non-current liabilities/ capital employed) * 100

Question 18

capital employed formula

Answer 18

non-current liabilities + equity

Question 19

strategies to improve stock turnover ratio

Answer 19

• supplying narrowe range of goods
• selling obsolete stock, stocking goods in high demand
• just-in-time stock control

Question 20

benefits of a narrower range of goods

Answer 20

simplifies the stock, increases the control over stock and can reduce stock quantities

Question 21

limitations of a narrower range of goods

Answer 21

simplifying the product portfolio and offering reduced choice to customers may negatively affect sales revenues if fewer items are sold as a result

Question 22

benefits of selling obsolete stock, stocking goods in high demand

Answer 22

reducing unpopular stock items can reduce stocks.
selling goods in high demand will increase sales of stocks.
saves of storage costs.

Question 23

limitations of selling obsolete stock, stocking goods in high demand

Answer 23

simplifying the product portfolio and offering reduced choice to customers may negatively affect sales revenues if fewer items are sold as a result

Question 24

benefits of just-in-time stock control

Answer 24

stock could be ordered only when needed for the production process.
ensures there is no excess stock

Question 25

limitations of just-in-time stock control

Answer 25

delays in supply chains can cause the business to run out of stock, reducing sales revenues and causing customer dissatisfaction

Question 26

strategies to improve debtor days

Answer 26

- 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

Question 27

benefits of having customers pay in cash

Answer 27

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

Question 28

benefits of shortening the credit period

Answer 28

debtors pay sooner, so debtor days decrease

Question 29

benefits of improving credit control

Answer 29

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

Question 30

benefits of refusing to do business with customers who pay late

Answer 30

stopping deliveries to customers who have not yet paid for the product should also bring faster payment, reducing debtor days

Question 31

benefits of threatnening legal action or imposing a penalty

Answer 31

threaten legal action against customers who do not pay for delivered products could charge interest on overdue amounts

Question 32

limitations of strategies to improve debtor days

Answer 32

upset customers, decreasing sales revenue business needs balance its own need to reduce debtors with its customers' needs for flexible payment

Question 33

strategies to improve (reduce) gearing ratio

Answer 33

- paying off liabilities - increasing retained profit - selling more shares

Question 34

benefits of paying off liabilities

Answer 34

businesses can pay their long-term liabilities to reduce gearing ratio

Question 35

limitations of paying off liabilities

Answer 35

less cash for daily operations, reducing sales revenue

Question 36

benefits of increasing retained profit

Answer 36

cost minimisation and increasing revenue increases value of denominator in the formula, thereby decreasing the gearing ratio

Question 37

limitations of increasing retained profit

Answer 37

reducing dividends to shareholders, making them unhappy

Question 38

benefits of selling more shares

Answer 38

increase the denominator and consequently decrease the gearing ratio increase equity

Question 39

limitations of selling more shares

Answer 39

dilute ownership of the company and reduce dividends to shareholders

Question 40

insolvency

Answer 40

situation where business is unable to pay its debts

Question 41

bankruptcy

Answer 41

situation where an insolvent business has to follow a legal process to settle its debts

Question 42

conditions/ factors for insolvency

Answer 42

- debtor days too long - loss of sales revenue - increased costs - legal action (ie sued)