efficiency ratios

what are the three efficiency ratios

1. payables days

2. receivables days

3. inventory turnover

what is payables days

• efficiency ratio that measures the average number of days a business takes to pay its suppliers

• a longer period can improve cash flow, but may harm supplier relationships

formula for payables days

accounts payables / cost of sales x365

what are the advantages of payables days 

• a longer period can improve a business’ cash flow by holding onto cash for longer 

• it can indicate a business has a strong negotiating position with its suppliers

what are the disadvantages of payables days

• taking too long to pay can damage supplier relationships, potentially leading to loss of trade credit or late payment changes 

• may indicate a liquidity problem or inability to pay bills on time 

what is receivable days

• efficiency ratio that measure the average number of days it takes for a business’ customers to pay their outstanding credit invoices 

• a lower number is generally better 

what is the formula for receivables days 

accounts receivable / revenue x365

what are the advantages of receivables days

• a lower number indicates efficient cash collection and strong cash flow 

• shows that the business has effective credit control policies in place 

what are the disadvantages of receivables days 

• if the number is too low, it may suggest the business’ credit terms are too strict, potentially loosing out on sales to competitors 

• a higher or increasing number can signal cash flow problems or that customers are in financial difficulty 

what is inventory turnover 

• efficiency ratio that measures how many times a business sells and replaces its inventory over a period, usually a year

• it indicates the efficiency of inventory management 

what is the formula for inventory turnover

cost of sales/ average inventory held

formula for average inventory

(beginning inventory + ending inventory) /2

advantages of inventory turnover

• a high turnover indicates strong sales and efficient inventory management, minimising storage costs

• reduces the risk of obsolete stock for businesses selling perishable or fast-moving goods

what are the disadvantages of turnover

• a very high turnover may mean the business is holding too little stock, risking stockout and cost sales

• the ideal rate varies significantly by industry