Efficiency ratio is a measure of business success. It helps us determine how much inputs have we supplied and how much did we receive from our ventures. It tells you about how efficiently you have utilized your assets and liabilities to gain name, fame and money from your firm.
Importance of Efficiency ratios-
Owning a business venture it’s extremely crucial to know where it’s heading towards. Are we under trading or are we overdoing it. There is not a uniform efficiency ratio that can tell you all. There are several types of efficiency ratios that need to be calculated in order to get your questions answered. Every ratio gives you information regarding a separate department. The ratios which are mostly used by companies for evaluation include the following:
Efficiency ratio of collection period: This ratio helps you to know about accounts receivables and the total collectability. In other words its measure of speed of cash collection and supply. Although credit terms are established by every firm, they are not often noticed by customers. In analysis you must include the terms as well. This would ease up knowing quality of collectables. Each company has his own rules regarding collection of payments from customers but its usually believed that 10 to 15 days over is a serious concern. Following is the formulae used for collection period ratio:
Formulae: Total receivable ÷ (Sales x 365)
Ratio of Assets to sales: It’s aEfficiency ratio of sales. It makes you know about overall sales against the invested capital. If very high, this ratio indicates some abnormality in business and that sales are not compatible to the investment made. It denotes lack in efforts to breed the sales. A lower percentage is also cause of concern. It denotes sales are exceeding then what your assets can securely cover.
Formulae: Total asset worth ÷ Net sales
Sales to working capital ratio: It’s the measure of working capital turnover over the net sales. This one has to be reviewed in relation with assets to sales ratio. A higher number indicates your venture is overtrading i.e. sales volume are worth more than investment worth of business. Another thing that we know from this figure is condition of operating funds. Higher number says you rely excessively on bank and suppliers credit. Formulae for calculating it is given below:
Formulae: net sales volume ÷ working capital worth
Ratio of account liability to net sales: It’s of great use to know company transactions and how much efficiently they are moving on. It denotes the flow of money from sales volume to payment of suppliers. Lower the ratio percentages better the transaction condition. If the ratio is high understand that your business is relying higher upon the suppliers finance and operations. Following is the way to calculate this ratio.
Formulae: Accounts liability ÷ Total sales.
These are five key efficiency ratios that help determining financial condition of business. Efficiency ratios are very important part of annual reports. You must know how to interpret each ofEfficiency ratio to have better overall analysis.
