Use of Efficiency Ratios in Financial Analysis
Financial analysts consider these ratios a vital measure of the short-term and current performance of a company. The analysts’ screen through the financial statements of a company including the income statement and balance sheet for aggregating the numbers to calculate efficiency ratios
After getting the numbers, the efficiency ratios are compared with peer companies to get an overview of the way a company performs relative to the competitors. There is a huge correlation between profitability ratios and efficiency ratios. If companies allocate their resources efficiently, they can become profitable. When the efficiency ratios have improved over a time period, it indicates the company has become profitable. This is discussed in our Financial Efficiency Ratios assignment help online.
The Popular Efficiency Ratios
The popular efficiency ratios are summarized as follows:
Inventory Turnover Ratio
It is a ratio that expresses the number of times a company sells its goods within a time period. It is calculated by considering the cost of goods sold on the average inventory within a specific time period.
The formula is Cost of Goods Sold/Average Inventory
Accounts Receivable Turnover Ratio
This ratio evaluates the efficiency to collect revenue. It measures the number of times the company collects the accounts receivable in a given period.
Net Credit Sales/Average Accounts Receivable
Where Net credit sales are the sales proceeds that are collected at a later date. The Net credit Sales= Credit Sale-Sales allowances-Sales returns
Average accounts receivable is the addition of beginning and ending balances of accounts receivable over a period of time.
Accounts Payable Turnover Ratio
This turnover ratio depicts the average number of times the company pays off the creditors with an accounting period. This ratio measures the short-term liquidity. If the payable turnover ratio is higher it is favorable because the company can hold cash for a long time.
The formula is Net Credit Purchases/Average Accounts payable
Net Credit purchases = COGS + Closing Balance - Beginning inventory balance. These purchases are made only on credit.
Average accounts payable is the addition of the beginning and closing accounts payable balances divided by 2.
Asset Turnover Ratio
The formula is Net Sales/Average Total Assets
Net Sales = Sales-Sales returns - Sales allowances - Sales discounts
Average Total Assets = (Total assets at the beginning + Total assets at the end)/2
As stated in our Financial Efficiency Ratios assignment paper help, these ratios are highly useful for a company to evaluate the operations of a company. Lenders and investors use these ratios while performing financial analysis to determine whether ratios represent a good creditworthy borrower or a good investment.