⚙️ What Are Efficiency Ratios?
Definition: Efficiency ratios measure how well a business manages its assets and liabilities — specifically stock, debtors and creditors.
While profitability ratios tell you about profit, and liquidity ratios tell you about short-term survival, efficiency ratios reveal how effectively the business manages its day-to-day operations.
Think of efficiency ratios as measuring the SPEED of money flowing through the business — faster is usually better! 🏎️
📦 Stock Turnover Ratio
Formulas: Stock turnover (times) = Cost of goods sold ÷ Average stock
Stock turnover (days) = (Average stock ÷ COGS) × 365
Stock turnover measures how many times a business sells and replaces its stock in a year, or how many days stock sits in the warehouse before being sold.
Example: COGS = $200,000. Average stock = $25,000. Stock turnover = $200,000 ÷ $25,000 = 8 times per year Stock turnover (days) = ($25,000 ÷ $200,000) × 365 = 46 days
- Higher turnover (more times) = stock sells FASTER (generally good)
- Lower days = stock doesn't sit around for long (less waste, less tied-up cash)
- Supermarkets have very high turnover; jewellers have low turnover — context matters!
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📅 Debtor Days & Creditor Days
Debtor days (receivable days)
Formula: Debtor days = (Trade receivables ÷ Sales revenue) × 365
This measures how long it takes customers to pay. Lower is better — faster collection improves cash flow.
Example: Trade receivables = $40,000. Revenue = $400,000. Debtor days = ($40,000 ÷ $400,000) × 365 = 37 days
Creditor days (payable days)
Formula: Creditor days = (Trade payables ÷ Cost of goods sold) × 365
This measures how long the business takes to pay its suppliers. Higher can be better (keeps cash longer) — but not so high that suppliers get upset!
Ideal: Creditor days > Debtor days. This means you collect from customers BEFORE you have to pay suppliers — free cash flow! 💰
🔧 Improving Efficiency Ratios
Improve stock turnover
- Use just-in-time (JIT) stock management
- Run promotions to clear slow-moving stock
- Improve demand forecasting
- Reduce product range to focus on best sellers
Reduce debtor days
- Offer early payment discounts
- Tighten credit terms
- Chase overdue invoices more aggressively
- Use factoring (sell debts to a third party)
Manage creditor days
- Negotiate longer payment terms with suppliers
- But always pay within agreed terms to maintain good relationships
- Take advantage of early payment discounts when cash allows