Course 304: Interpreting the Numbers
Efficiency Ratios
In this course
1 Introduction
2 How to Use Financial Ratios
3 Efficiency Ratios
4 Liquidity Ratios
5 Leverage Ratios
6 Profitability Ratios
7 The Bottom Line

No matter what kind of business a company is in, it must invest in assets to perform its operations. Efficiency ratios measure how effectively the company utilizes these assets, as well as how well it manages its liabilities.

Inventory Turnover. Inventory turnover illustrates how well a company manages its inventory levels. If inventory turnover is too low, it suggests that a company may be overstocking or overbuilding its inventory or that it may be having issues selling products to customers. All else equal, higher inventory turnover is better.

Inventory Turnover = (Cost of Sales) / (Average Inventory)

Accounts Receivable Turnover. The accounts receivable turnover ratio measures how effective the company's credit policies are. If accounts receivable turnover is too low, it may indicate the company is being too generous granting credit or is having difficulty collecting from its customers. All else equal, higher receivable turnover is better.

Accounts Receivable Turnover = Revenue / (Average Accounts Receivable)

Accounts Payable Turnover. You'll notice that the accounts payable turnover ratio uses a liability in the equation rather than an asset, as well as an expense rather than revenue. Accounts payable turnover is important because it measures how a company manages paying its own bills. High accounts payable turnover may be a signal that a firm isn't receiving very favorable payment terms from its own suppliers. All else equal, lower payable turnover is better.

Accounts Payable Turnover = (Cost of Sales) / (Average Accounts Payable)

Total Asset Turnover. Total asset turnover is a catch-all efficiency ratio that highlights how effective management is at using both short-term and long-term assets. All else equal, the higher the total asset turnover, the better.

Total Asset Turnover = (Revenue) / (Average Total Assets)

Next: Liquidity Ratios >>


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