Efficiency Ratios: Definition, Types & Formulas

Understand

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

Asset Turnover Ratio

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

Working Capital Ratio

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.

Return on Investment (ROI) Ratio

It measures earnings with respect to the particular invested amount and usually expressed in percentage.

ROI = Net profit / (The cost of an investment) * 100

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