POFM- efficiency ratio Flashcards
efficiency
o Refers to how well the business is using their resources
o Financial statements needed to calculate efficiency are the revenue statement and balance sheet
what is a expense ratio
It shows how well the business is keeping its expenses under control and how long it takes for the business to receive money from accounts receivable
Although a business may generate high sales revenue, this does not mean that it is achieving these high revenues at the lowest costs possible
The more efficient the business is the greater its profits and financial stability.
Efficiency ratio are used in conjunction with liquidity and profitability ratios to gain a complete picture off a business’s performance.
The two efficiency ratios are
- Expenses ratio
2. Accounts receivable turnover ratio
what does this expense ratio show
the expenses of a business as a proportion of total sales, giving an indication of how costs effectively the business is able to generate its sales revenue
measures the proportion or each sales dollar that is absorbed by expenses and reflects the efficiency with which costs are managed
indicates the day-to-say efficiently of the business. The business aims to keep expenses at a reasonable level
A financial manager might want to analyse a capitular area of the business:
- Financial expenses (interest paid)
- Selling expenses (marketing costs)
- Operations (manufacturing costs)
calculating expense ratio
Each of the categories of expenses can also be compared to sales e.g.: if the selling expenses has increased, it may be that advertising costs have not generated the expected increases in sales
Expenses ratios should be examined carefully as some expenses will be fixed while others will fluctuate according to the level of sales. The ratio should eb compared wit competitors or against prior years to monitor trends
expense ratio=
total expenses/sales x 100
o It is always written as a percentage i.e. x% and shows how much of every $1of sales is used to pay for total (or specific) expenses.
what does this all mean?
measures the relationship between total revenue (or sales) and the total expenses incurred to generate this revenue
allows a judgement about how efficient the business is in expanding their financial resources
Are they getting bank for their buck?
A financial manager would want the expense ratio to as lower as possible but they would also look at how it compares with other businesses in the industry and how the business fared in previous financial years
Furthermore, they would also look at which expenses appear to be contributing the most and if they are necessary
