Efficiency Ratios are used to measure business performance by analyzing how well a company is utilizing its resources to generate revenue. These ratios deal with an operational aspect of the company such as how many times the company turns its receivable balances into cash, the company ability to generate profit by utilizing assets and how well the company is managing inventory level etc.
Types of Efficiency Ratios
The most common ratios are being discussed hereunder:
Account Receivable Turnover Ratio
It is used to measure how efficient and effective are credit policies of a company. The high account receivable turnover ratio is recommended and it is calculated by using formula hereunder:
Account Receivable Turnover = Revenue / Average Accounts Receivable
The ratio measures how well a company’s long-term and current assets are being utilized to generate sales, high asset turnover ratio is considered as favorable and the formula is:
Asset Turnover Ratio = Revenue / Average Total Assets
The ratio (also called current ratio) measures how many dollars of current assets are available to pay off company’s short-term liabilities.
Working Capital Ratio = Current Assets / Current Liabilities
Inventory Turnover Ratio
It is a tool to gauge how well and effectively company’s inventories are being managed. For example, a company purchases more inventory than need, causing the unnecessary increased cost of goods sold, which depicts that inventories are managed poorly. In that case, the result of formula will decrease, which is not considered favorable.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Operation Expense Ratio
Operating Expense Ratio = Operating Expenses / Revenue
The formula is used to measure how much has been spent in the operation of a property for generating its income. High operating expense ratio signals that corrective action should be taken to cause costs minimized.
It measures earnings with respect to the particular invested amount and usually expressed in percentage.
ROI = Net profit / (The cost of an investment) * 100