Asset Turnover Ratios or Efficiency Ratios

Asset turnover ratios indicate how efficiently the firm utilizes its assets as well as how well it manages its liabilities. They are sometimes referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Three commonly used asset turnover ratios are receivables turnover, payable turnover and inventory turnover.

Accounts Receivables turnover ratio

Accounts receivable turnover ratio is an indication of how quickly the firm collects its accounts receivables. It shows how quickly your credit customers are paying you. The greater the number of times receivables turn over during the year, the shorter the time between the sale and collecting the cash for that sale. It measures the effectiveness of your credit management policies with extending credit and collecting debts.

It is defined as:

accounts-receivables-turnover-ratio-onestopbrokers

 The higher the ratio, the faster your business collects its accounts receivables and the more cash it has available. Businesses that operate on a mainly cash basis will have a high ratio. A low ratio indicates inefficient management of debtors or less liquid debtors. The business needs to re-assess its credit management procedures to ensure faster collection of debts.

Average Collection period

The average collection period shows the average number of days it takes your business to collect payment for sales to customers on credit. The speed at which bills are collected has a significant impact on the cash flow of your business. Use this ratio to determine how long your business’s money is being tied up in customer credit.

It is the accounts receivable balance divided by the average daily credit sales, calculated as follows:

 average-collection-period-onestopbrokers

The collection period can also be written as:

 average-collection-period2-onestopbrokers

Accounts payable turnover ratio

The accounts payable turnover ratio shows how quickly your business pays its bills and how often payables turn over during the year. Trends in the accounts payable turnover ratio demonstrates how your business handles its outgoing payments and can help you assess the cash situation of your business.

The formula used to calculate the accounts payable turnover ratio is:

accounts-payable-turnover-ratio-onestopbrokers

Average payment period

The average payment period shows the average number of days it takes your business to make payment for purchases on credit. A high ratio means there is a relatively short time period between purchasing inventory or materials and paying for them. A low ratio may indicate that your business has a problem with cash shortages.

The formula used to calculate the average collection period is:

 average-payment-period-onestopbrokers

 The average payment period can be written as:

average-payment-period2-onestopbrokers

 

Inventory turnover ratio

The inventory turnover ratio tells you the number of times your inventory turns over during the year. It indicates how quickly inventory is sold and replaced in the operating period.

Generally, a high inventory turnover ratio is an indicator of high demand for your products and good inventory management. However, a high ratio can also mean there is a shortage of inventory and your business is losing sales because of inadequate stock on hand.

A low inventory turnover ratio may indicate that inventory is naturally slow moving in your industry, or that you are carrying too much or obsolete inventory. Inventory that is turning over too slowly could hamper your cash flow, and your business will tend to require higher working capital.

It is the cost of goods sold in a time period divided by the average inventory level during that period:

 inventory-turnover

 Inventory period

The inventory turnover is often reported as the inventory period, which is the number of days worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods sold.

This is a good indication of production and purchasing efficiency. A high ratio indicates inventory is selling quickly and that little unused inventory is being stored (or could also mean inventory shortage). If the ratio is low, it suggests overstocking, obsolete inventory or selling issue.

inventory-period-onestopbrokers

 The inventory period can also be written as:

inventory-period2-onestopbrokers

 

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