Financial Efficiency Ratios

Financial Efficiency Ratios

There are three main ratios that can be used to measure the financial efficiency of a business:

  1. The asset turnover ratio.
  2. The stock turnover ratio.
  3. The debtor days ratio.

This measures the productivity of the business (i.e. how many pounds worth of sales revenue can be generated from the assets employed?). It is calculated using the following formula:

Copyright S-cool

For example, if a business has sales revenue of £8 million and net assets of £5 million, then the asset turnover ratio would be:

Copyright S-cool

This means that for every £1 of net assets, the business generates £1.60 of sales revenue. Clearly the higher the answer, the better. It is normal for service industries (e.g. supermarkets) to have a much higher asset turnover ratio than manufacturing industries, since service industries generate very high sales in relation to their net assets.

This measures the number of times in a 12-month period that a business sells its stock. It is calculated using the following formula:

Copyright S-cool

For example, if a business has a 'cost of goods sold' figure of £2 million and an average 'stock' figure of £0.5 million, then the stock turnover ratio would be:

Copyright S-cool

This means that the business would turn its stock over (i.e. sell the lot and order some more) four times per year, or every 91 days on average. However, care must be taken when comparing the stock turnover ratios of different businesses, since a supermarket, for example, is likely to have a much higher stock turnover (especially for vegetables, fruit and other perishables) than a retailer such as 'Dixons' (for televisions, washing machines, etc).

This shows how long, on average, a business takes to collect the debts owed to it by customers who have purchased their goods on credit. It is calculated using the following formula:

Copyright S-cool

For example, if a business had debtors of £1.2m and a sales turnover of £9.1m, then the debtor days figure would be:

Copyright S-cool

This means that, on average, it takes the business 48 days to collect its trade debts. This may be due to a poor debt-collection system, or it may be due to the fact that it allows customers a number of weeks before payment is due as part of its marketing strategy.

Ideally, the sooner the business receives all the cash from sales revenue, the better, since it can be used to boost the day-to-day capital (working capital) that is available to pay bills, etc.

S-cool exclusive FREE TUTORIAL offer!