Efficiency ratios Flashcards
What do efficiency ratios measure?
How well is capital used to generate revenue?
What are the two types of efficiency ratios?
- Efficiency of working capital
- Efficiency of capital employed
What is working capital?
Short-term capital available for day-to-day business activities after settling short-term liabilities
How is working capital calculated?
current assets - current liabilities
What are examples of short-term liabilities?
Trade payables, accrued expenses
What does it mean if working capital is too high?
You’re holding too much in inventory (costly), trade receivables (risky) or cash (inefficient)
What are the three main working capital ratios?
- Average inventory turnover period
- Average settlement period for trade receivables
- Average settlement period for trade payables
What does ‘inventory days’ refer to?
Average inventory turnover period
What does ‘trade receivable days’ refer to?
Average settlement period for trade receivables
What does ‘trade payable days’ refer to?
Average settlement period for trade payables
What does inventory days measure?
How long does it take to sell average inventory?
What is the formula for inventory days?
average inventory / CoGS x 365
What is the formula for inventory turnover?
CoGS / average inventory
What is the formula for trade receivable days?
average trade receivables / credit sales x 365
What is the formula for trade receivables turnover?
credit sales / average trade receivables
What is the formula for trade payable days?
average trade payables / credit purchases x 365
What is the formula for trade payables turnover?
credit purchases / average trade payables
What does trade receivables days measure?
How long does it take to receive average trade receivables?
What does trade receivables turnover measure?
How many times did you convert average trade receivables into cash?
What does trade payables days measure?
How long does it take to pay average trade payables?
What does trade payables turnover measure?
How many times did you convert average trade payables into cash?
What is one reason for high inventory days?
Stocking up in anticipation of increased demand
What is one reason for high trade receivables days?
Offering generous terms to attract new customers
What is one reason for high trade payables days?
Free source of short-term borrowing
What is one risk of high trade payables days?
Reputational damage, damage to relations with suppliers
What are the main capital employed ratios?
- Return on capital employed
- Net asset turnover
- Asset turnover
- Non-current asset turnover
What is the formula for net asset turnover?
sales revenue / capital employed
What are two ways of calculating capital employed?
- equity + non-current liabilities
- assets - current liabilities
What is one way of breaking down ROCE?
operating profit margin x net asset turnover
What is the formula for asset turnover?
sales revenue / total assets
What is the formula for non-current asset turnover?
sales revenue / non-current assets
What sort of companies find non-current asset turnover the most useful?
Non-current asset intensive companies e.g. manufacturers
