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Efficiency ratios

Efficiency ratios - these ratios describes the quality of a business' activities in collecting money and how efficiently it uses and controls its assets such as inventory. It also shows how effectively the company is paying for the suppliers. This group consists of ratios like: day sales outstanding, inventory turnover, assets to sales, sales to net working capital, payable turnover ratio, and so on.

Day sales outstanding ratio shows how fast the company is collecting its money from customers and how fast it can increase its cash supply. Every company has its own rules for establishing credit terms for the customers, and usually it takes several days to collect money. Only if the company is selling on the internet, it will have the best day sales outstanding ratio, because online shops are collecting money first and only after that it provides bought items or services. The other ratio - inventory turnover shows how the company is controlling its inventory, maybe it is stocked for too long, or maybe the company is not able to bring enough inventories for the needed demand on the market. When calculating assets to sales ratio we evaluate how much of the assets are used to generate those sales. Sales to net working capital ratio – shows how effectively working capital is used in relation to net sales. Payable turnover ratio – evaluates the period the company pays for its suppliers.

As you could understand, efficiency ratios are very important for the company, because the profitability of the company depends on the efficiency of its activities. So if the company is able to control the inventories, collect money from the customers and use its assets to generate sales, then the company will show good efficiency ratios, which will lead to higher earnings and better profits.