EFFICIENCY RATIOS

EFFICIENCY RATIOS

1. INVENTORY TURNOVER=COST OF SALES/AVG INVENTORY

   • This shows how quickly inventory is sold; higher turnover reflects faster-moving inventory.

2. INVENTORY DAYS=AVG INVENTORY/ANNUAL COST OF SALES*365

   • Inventory days estimates the time taken for inventory to be sold. Everything else being equal a business would prefer lower inventory days

3. TRADE RECEIVABLE DAYS = AVG TRADE RECEIVABLE/ANNUAL CREDIT SALES*365

   • n exam questions you may have to assume that: (i) year-end receivables are representative of the average figure; and (ii) all sales are made on credit.
   • Receivables days estimates the time taken for customers to pay. Everything else being equal a business would prefer lower receivables days.

4. TRADE PAYABLE DAYS= AVG TRADE PAYABLE/ANNUAL PURCHASE*365

   • In exam questions you may have to assume that: -Year-end payables are representative of the average figure -Cost of sales approximates annual credit purchases -All purchases are made on credit.
   • Payables days estimates the time taken to pay suppliers. A business would prefer to increase its payables days, unless this proves expensive in terms of lost settlement discounts or leads to other problems such as a damaged reputation

5. SALES TO WORKING CAPITAL=ANNUAL SALES/AVG WC

   • In exam questions you may have to assume that year-end working capital is representative of the average figure over the year.
   • In this ratio working capital is defined as the level of investment in inventory and receivables less payables.
   • The sales to working capital ratio indicates how efficiently working capital is being used to generate sales.