Chapter 38- efficiency ratios

Question 1

Financial efficiency ratios

Answer 1

• measure the ability of a business to mange its assets and liabilities efficiently
• ratios include non-current asset turnover, stock turnover, debtor turnover (days) and creditor turnover (days)

Question 2

Financial efficiency

Answer 2

Ratios included
- non current asset turnover
- inventory turnover (stock turnover)
- debtor days (turnover)
- creditor days (turnover)

Concerned with
- concentrate on the efficiency of the business in terms of its ability to move stock and how efficient it is as collecting money it is owed or it owes

Question 3

Asset turnover

Answer 3

• measures how efficiently a business is able to use its non current assets to generate sales revenue
• the higher the ratio the better as it implies that the assets are being used in a more efficient manner to generate sales revenue

Question 4

Non current assets turnover formula

Answer 4

Revenue (turnover)/ non-current assets
E.g.
Revenue- 275000
Non current assets- 800000

275000/800000= 0.344

Suggests that the business is not very efficient in terms of sales revenue generated from the non current assets of the business
- for every 1 pound of non current assets only 34p of sales is generated

Question 5

Stock (inventory) turnover

Answer 5

• measures how quickly the stock is turned over (sold)

Question 6

Stock (inventory) turnover formula

Answer 6

Stock (inventory) turnover= cost of stock (for sales)/ average stock

Average stock (inventory) can be easily calculated by adding the opening stock to the closing stock and dividing by 2

E.g.
stock inventory turnover= cost of stock/ average stock

25,000/10000= 2.5

This mean that the stock was sold 2.5 times within the trading period of one year
If the business needs to find out how many days it takes to turn the stock over this can be calculated by:

Stock (inventory)/ cost of sales x 365

• may be helpful in assessing reorder and delivery patterns

Question 7

What would a high inventory stock turnover be due to?

Answer 7

The usage of JIT
- as less inventory/ stock is held and therefore the stock will be turned over more quickly

Question 8

Why may the rate of turnover fall

Answer 8

• due to increased levels of inventory (stock) in order to ensure that there is sufficient inventory (stock) to meet a predicted increase in demand

Question 9

Debtor days (trade receivables days)

Answer 9

• measures how quickly debts are turned into cash
• how quickly the money owing to the business is paid
• represents the average amount of time (days) which the debtors of the business take to pay
• ratio can be used to measure how efficiently a business collects its debts
• keeping debtor days as low as possible will help the cash flow of the business

Question 10

Debtor days (trade receivables days) formula

Answer 10

Debtor days= trade receivables/ revenue (sales) x 365

Question 11

Creditor days/ turnover (trade and payables)

Answer 11

• measures how quickly a business pays its suppliers
• shows the numbers of days which a business takes on average to pay money it owes to its suppliers
• being able to delay payment to its suppliers helps the cash flow of the business

Question 12

Creditor days/ turnover (trade and payables) formula

Answer 12

Creditor days= trade payables/ purchases (cost of sales) x 365