Efficiency ratios

Question 1

What do efficiency ratios measure?

Answer 1

How well is capital used to generate revenue?

Question 2

What are the two types of efficiency ratios?

Answer 2

1. Efficiency of working capital
2. Efficiency of capital employed

Question 3

What is working capital?

Answer 3

Short-term capital available for day-to-day business activities after settling short-term liabilities

Question 4

How is working capital calculated?

Answer 4

current assets - current liabilities

Question 5

What are examples of short-term liabilities?

Answer 5

Trade payables, accrued expenses

Question 6

What does it mean if working capital is too high?

Answer 6

You’re holding too much in inventory (costly), trade receivables (risky) or cash (inefficient)

Question 7

What are the three main working capital ratios?

Answer 7

1. Average inventory turnover period
2. Average settlement period for trade receivables
3. Average settlement period for trade payables

Question 8

What does ‘inventory days’ refer to?

Answer 8

Average inventory turnover period

Question 9

What does ‘trade receivable days’ refer to?

Answer 9

Average settlement period for trade receivables

Question 10

What does ‘trade payable days’ refer to?

Answer 10

Average settlement period for trade payables

Question 11

What does inventory days measure?

Answer 11

How long does it take to sell average inventory?

Question 12

What is the formula for inventory days?

Answer 12

average inventory / CoGS x 365

Question 13

What is the formula for inventory turnover?

Answer 13

CoGS / average inventory

Question 14

What is the formula for trade receivable days?

Answer 14

average trade receivables / credit sales x 365

Question 15

What is the formula for trade receivables turnover?

Answer 15

credit sales / average trade receivables

Question 16

What is the formula for trade payable days?

Answer 16

average trade payables / credit purchases x 365

Question 17

What is the formula for trade payables turnover?

Answer 17

credit purchases / average trade payables

Question 18

What does trade receivables days measure?

Answer 18

How long does it take to receive average trade receivables?

Question 19

What does trade receivables turnover measure?

Answer 19

How many times did you convert average trade receivables into cash?

Question 20

What does trade payables days measure?

Answer 20

How long does it take to pay average trade payables?

Question 21

What does trade payables turnover measure?

Answer 21

How many times did you convert average trade payables into cash?

Question 22

What is one reason for high inventory days?

Answer 22

Stocking up in anticipation of increased demand

Question 23

What is one reason for high trade receivables days?

Answer 23

Offering generous terms to attract new customers

Question 24

What is one reason for high trade payables days?

Answer 24

Free source of short-term borrowing

Question 25

What is one risk of high trade payables days?

Answer 25

Reputational damage, damage to relations with suppliers

Question 26

What are the main capital employed ratios?

Answer 26

1. Return on capital employed
2. Net asset turnover
3. Asset turnover
4. Non-current asset turnover

Question 27

What is the formula for net asset turnover?

Answer 27

sales revenue / capital employed

Question 28

What are two ways of calculating capital employed?

Answer 28

1. equity + non-current liabilities
2. assets - current liabilities

Question 29

What is one way of breaking down ROCE?

Answer 29

operating profit margin x net asset turnover

Question 30

What is the formula for asset turnover?

Answer 30

sales revenue / total assets

Question 31

What is the formula for non-current asset turnover?

Answer 31

sales revenue / non-current assets

Question 32

What sort of companies find non-current asset turnover the most useful?

Answer 32

Non-current asset intensive companies e.g. manufacturers