EFFICIENCY RATIOS

• Efficiency ratios, otherwise known as turnover

ratios, are called such because they measure
the management’s efficiency in utilizing the
assets of the company.
• These are typically used to analyze how well a
company uses its assets and liabilities
internally.
• It is also known as activity ratio.
EFFICIENCY RATIOS
• An efficiency ratio can calculate the turnover
of receivables, the repayment of liabilities, the
quantity and usage of equity, and the general
use of inventory and machinery.
• All of these ratios use numbers in a company's
current assets or current liabilities, quantifying
the operations of the business.
Different Efficiency Ratios
What EFFICIENCY RATIOS will be
discussed in this chapter?

1. Total Asset Turnover Ratio

2. Fixed Asset Turnover Ratio
3. Accounts Receivable Turnover Ratio
4. Inventory Turnover Ratio
5. Accounts Payable Turnover Ratio

From these three ratios, operating cycle and

cash conversion cycle can be computed.
 Total Asset Turnover Ratio
• Total asset turnover ratio measures the
company’s ability to generate revenues for
every peso of asset invested.
• Asset turnover ratio is typically calculated over
an annual basis using either
the fiscal or calendar year.
• The higher the asset turnover ratio, the better
the company is performing.
 Total Asset Turnover Ratio
The formula for Total Asset Turnover Ratio is:
Sales
Asset Turnover Ratio =
Total Assets

Note: In calculating the asset turnover ratio,

ending balance or average of the total assets
can be used. Whichever formula, consistency
must be applied.
Example:
Wal-Mart Target AT&T Verizon
(in millions)
Stores Corp. Inc. Communications

Beginning Assets $199,581 $40,262 $402,672 $244,175

Ending Assets $198,825 $37,431 $403,821 $244,180

Average Total $403,246.

$199,203 $38,846.50 $244,177.50
Assets 50

Revenue $458,873 $69,495 $163,786 $125,980

Asset Turnover
2.30 1.79 0.41 0.52
Ratio
Fixed Asset Turnover Ratio
• The fixed-asset turnover ratio is, in general,
used by analysts to measure operating
performance of a company.
• It is a ratio of net sales to fixed assets.
• This ratio specifically measures how able a
company is to generate net sales from fixed-
asset investments, namely property, plant and
equipment (PP&E), net of depreciation.
Fixed Asset Turnover Ratio
• The fixed-asset turnover ratio is calculated as:
Sales
Fixed Asset Turnover Ratio =
PPE
• While a higher ratio is indicative of greater
efficiency in managing fixed-asset investments,
there is not an exact number or range that
dictates whether a company has been efficient at
generating revenue from such investments.
 Accounts Receivable Turnover Ratio
• Accounts receivable turnover ratio measures
the efficiency by which accounts receivable
are managed.
• Its formula is:

Sales
A/R Turnover Ratio =
(Trade) Accounts Receivable
Accounts Receivable Turnover Ratio:
Average Collection Period
Total no. of days
Average Collection Period =
A/R Turnover Ratio

Note: The longer it takes for a company to collect its

accounts receivable is the more money they loses
because of the time value of money principle.
Inventory Turnover Ratio
• Inventory Turnover Ratio measures the
company’s efficiency in managing its
inventories.
• The formula is:
Sales or Cost of Sales
Inventory Turnover Ratio =
Inventories
Inventory Turnover Ratio:
Day’s Inventory
Total no. of days
Days’ Inventories =
Inventory Turnover Ratio

Note: The result suggest the time it takes for a

company to sell and replace its inventories.
Accounts Payable Turnover Ratio
• Accounts payable turnover ratio provides
information regarding the rate by which trade
payables are paid.
• The formula is:
*Cost of Sales
A/P Turnover Ratio =
Trade Accounts Payable
*Total Purchases
Accounts Payable Turnover Ratio:
Days ‘Payable
Total no. of days
Days’ Payable =
Accounts Payable Turnover Ratio

NOTE: The result suggests the average payment

period of the company for its trade accounts
payable.
Operating Cycle
• Operating cycle covers the period from the
time the merchandise is bought to the time
the proceeds from the sale are collected.
• Its formula is:

• Mangers prefer to have short operating cycle.

Cash Conversion Cycle
• Cash conversion cycle is used to determine
how long it takes for a company to collect
receivables from the time the cost of the
merchandise sold was actually paid.
• It is also known as net trade cycle.
• Its formula is: