3.6 - Efficiency Ratio Analysis (HL - Unit 3)

Question 1

Insolvency

Answer 1

When a business can’t pay its debt when they are due to be paid

• No longer able to meet their financial obligations
• E.g. employees can’t be paid

Question 2

Bankruptcy

Answer 2

When a court of law judges that the business is unable to pay its debts

Often then the assets will be liquidated to their creditors

Key difference:

• Financial State = Insolvency
• Bankruptcy = Legal State

Question 3

Debtor Days

Answer 3

Average time it takes to collect money from debtors

(Debtors/Total Sales Revenue) x 365

• Keep it as short as possible

Question 4

Creditor Days

Answer 4

Average time it takes to pay suppliers

(Creditors/Cost of Sales) x 365

• Keep it as long as possible

Question 5

Strategies to improve Debtor Days

Answer 5

• Decrease debtor days
• Only accept cash payments - no trade credit
• Reduce trade credit - e.g. from 90 to 60 days

Question 6

Strategies to improve Creditor Days

Answer 6

• Increase creditor days
• Delay payments to suppliers
• Change suppliers who offer more trade credit

Question 7

Average Stock

Answer 7

(Opening Stock + Closing Stock)/2

Question 8

Stock Turnover Formula 1

Answer 8

How many times stock is bought in per year

• (Cost of Sales/Average Stock)

Question 9

Stock Turnover Formula 2

Answer 9

How many days does it take for the stocks to be sold

• (Average Stock/Costs of Sales) x 365

Question 10

Gearing Ratio

Answer 10

How reliant is the business on Non-Current Liabilities, i.e. loans

• (Non-Current Liabilities/Capital Employed) x 100
• < 25% = low-risk
• 25% < x < 50% = optimal or normal
• > 50% = greater financial risk

Question 11

Strategies to Improve Gearing Ratio

Answer 11

• Sell assets and repay loans
• Sell shares to repay loans
• Pay less dividends