Efficiency ratio analysis Details Flashcards
Types of efficiency ratios
-Stock turnover ratio
-Debtor days ratio
-Creditor days ratio
-Gearing ratio
Formula for stock turnover ratio(number of times)
Cost of sales ÷ Average stock
Formula for stock turnover ratio(number of days)
(Average stock ÷ Cost of sales) × 365
Formula for average stock
(Opening stock + Closing stock) ÷ 2
What would a high stock turnover ratio mean?
The business is efficient; it can turn stock into sales revenue very quickly
What would a stock turnover ratio of n mean
the business sold out its stock n times a year, or every (365/n) days
Formula for debtor days ratio
(Debtors ÷ Sales revenue) × 365
Formula for creditor days ratio
(Creditors ÷ Cost of sales) × 365
The longer the creditor days, the better for the business(T/F)
True
The shorter the debtor days, the better for the business(T/F)
True
Formula for gearing ratio
What does a gearing ratio of n% mean?
n% of the business’s operations are funded by long-term debt
Strategies to improve the stock turnover ratio
-Supplying a narrower range of goods
-Selling obsolete stock and stocking goods in high demand
-Ordering stock only when needed for the production process(i.e. just-in-time stock control)
Strategies to improve the debtor days ratio
-Having customers pay in cash
-Shortening the credit period
-Improving credit control(e.g. by using stricter criteria for buying on credit)
-Refusing to do business with customers that pay late
-Threatening legal action or imposing a penalty for late paying customers
Strategies to improve the creditor days ratio
-Negotiating longer credit-periods
-Ordering stock only when needed for the production process(i.e. just-in-time stock control)
-Looking for different suppliers
Strategies to improve the gearing ratio
-Paying off long-term liabilities
-Increasing retained profit(e.g. through cost minimisation and sales revenue)
-Selling more shares(increasing share capital)
Possible reasons for insolvency
-Debtor days being too long
-Loss of sales revenue
-Increased costs
-Legal action(e.g. getting sued)
