3.6 Effieciency Ratio Analysis Flashcards
(12 cards)
State the purpose of efficiency ratios:
assess how well a business uses its resources, especially in managing inventory, debtors, and creditors.
These ratios help identify operational effectiveness and potential areas for cost savings.
What does stock turnover measure
Measures how quickly a business sells and replaces its stock over a period of time, usually 1 year. (number of times stock is converted into sales in a period of time, usually 1 year)
State 2 possible formulas of stock turnover + formula fri average stock + interpretation
Stock turnover (times) = Cost of Goods Sold (COGS) ÷ Average Stock
Stock turnover (days) = (Average Stock ÷ COGS) × 365
Average stock = (opening + closing) / 2
Interpretation:
Higher turnover = efficient stock management.
Low turnover = overstocking or slow-moving goods.
If this value falls = increased rate at which stock is sold and = improved cash flow
Better to gave more times and ñess days but by dosing this you do have economies of scale
What does debtor days measure / trade receivable
Measures how long on average it takes a business to collect payment from customers who bought on credit.
Formula debtor days + interpretation
Formula:
Debtor Days = (Debtors ÷ Revenue) × 365 = an answer in days
Interpretation:
Shorter = quicker cash inflow, better liquidity.
Longer = potential cash flow issues.
Increasing this value = improved cash flow bc decreased time takes debtors to pay
What does creditor days measure
Shows how long it takes a business to pay its suppliers on average.
Formula interpretation of creditor days / trade payables
Formula:
Creditor Days = (Creditors ÷ COGS) × 365
Interpretation:
Longer = better short-term liquidity, but may damage supplier relationships.
Shorter = more reliable to suppliers, but may hurt cash reserves.
Falling of this value = improved cash flow
Gearing ratio what does it measure
Measures the extent to which a business is financed by long-term debt as opposed to equity.
(How much a firm relies on external, long-term sources of finance as opposed to equity to finance their operations)( How much of their capital employed is not equity )
Gearing ratio formula & interpretation
Formula:
Gearing (%) = (Loan Capital ÷ Capital Employed) × 100
Capital employed = non-current liabilities + equity (or not assets) & loan capital anything we borrow more than a year
Interpretation:
0% = highly geared (higher risk)
<50% = low gearing (more conservative)
State 3 strengths of efficiency ratios
Identify inefficiencies in working capital.
Help businesses monitor operational targets.
Can benchmark performance against industry averages.
State 3 limitations of efficiency ratios
Only valid if data is reliable and comparable.
One ratio alone does not give full picture — must be analysed with others (e.g., profitability or liquidity)
Seasonal fluctuations may distort results.
If given data for efficiency ratios for 2 years for a business , what could be a limitation?
data only for 2 years which isn’t enough to see trends,
also not having data from the industry
