3.6 - efficiency ratio analysis

What do efficiency ratios show?

How well assets and liabilities are being used in a business to maximise profits

What are the efficiency ratios?

Stock turnover → the speed at which a firm sells and replenishes stock

Debtor days → the time taken for a business to collect money from debtors

Creditor days → the time taken for a business to pay its creditors

Gearing ratio → how much of a businesses funding comes from debt compared to equity

Is faster or slower stock turnover better?

Faster, as then more is sold, and more sales revenue is made. When benchmarking stock turnover of different companies, it is important to consider the industry they are in. E.g, a bakery’s stock turnover will be higher than a yachts

Name strategies to improve stock turnover

• Holding less stock by implementing Just-In-Time

• reduce the product range - only keeping best-selling products

Are lower or higher debtor days better?

Lower debtor days as then customers pay the business back earlier, and the business has better cash flow (however, this debtors days cannot be too short, as then customers may switch to other companies or suppliers)

The good benchmark is between 30 and 60 days

Name strategies to improve debtor days?

Impose late fees on late payers or discounts on early payers. Refuse further business with the client until further action is made. Develop close relationships with customers to make sure they pay on time

Are higher or lower creditor days better?

The lower the creditor days are, the better the business repays its suppliers (however, it should not be too low, as this means they have bad cash flow)

The benchmark is between 30 and 60 days

What is the gearing ratio?

It shows how much the capital employed in a firm comes from non-current liabilities or equity

Is it better if the gearing ratio is higher or lower?

If the benchmark is above 50%, then the firm is highly geared (more debt and more financial risk), which isn’t good

What does it mean if a firm is highly geared?

Then a large percentage of its capital comes from non-current liabilities (debts), rather than equity

What are strategies to improve the gearing ratio?

develop closer relationships with customers to reduce debtor days

develop closer relationships with suppliers to extend creditor days

introduce stock control methods, such as Just-In-Time production to reduce the amount of stock held

What is insolvency?

When firms are unable to settle their debts due to a lack of cash or funds

What is bankruptcy?

The formal declaration of a firm being unable to settle their debts due to a lack of cash or funds. The business has failed, and even when selling all of their assets, it would not be enough