Interpreting Accounts - Financial Efficiency Ratios

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In this revision presentation, we provide an overview of financial efficiency rations - which assess how effectively a business is managing its assets.

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Interpreting Accounts - Financial Efficiency Ratios

  1. 1. FinancialEfficiency Ratios
  2. 2. Financial efficiency ratios Assess how effectively abusiness is managing its assets
  3. 3. Financial efficiency ratios Asset turnover Stock turnover Debtor days Creditor days* Covered in BUSS2
  4. 4. Asset turnover Revenue (sales)Asset turnover = Net assets Example Example Revenue = £21,450k Revenue = £21,450k Net assets = £4,455k Net assets = £4,455k Asset turnover = 4.8 times Asset turnover = 4.8 times
  5. 5. Evaluating asset turnover• A rough guide to how intensively a business uses its assets• Some limitations of the ratio: – Takes no account of how profitable the revenue is – Less relevant for labour-intensive businesses – Will vary widely from industry to industry – Can fluctuate from year to year (e.g. major investment in fixed assets in one year generates increased sales in following years
  6. 6. Stock turnover Cost of salesStock turnover = Average stock heldExampleExample Cost of sales = £13,465k Cost of sales = £13,465k Average stock = £1,325k Average stock = £1,325k Stock turnover = 10.2 times Stock turnover = 10.2 times
  7. 7. Evaluating stock turnover• Interpreting the number – In general, a higher number is better – Low number (compared with previous period or competitors) suggests problem with stock control• Some issues to consider: – Stock turnover varies from industry to industry – Holding more stock may improve customer service & allow the business to meet demand – Seasonal fluctuations in demand during the year may not be reflected in the calculations – Stock turnover is irrelevant for many service sector businesses (but not retailers, distributors etc)
  8. 8. Actions to improve stock turnover• Sell-off or dispose of slow-moving or obsolete stocks• Introduce lean production techniques to reduce stock holdings• Rationalise the product range made or sold to reduce stock-holding requirements• Negotiate sale or return arrangements with suppliers – so the stock is only paid for when a customer buys it
  9. 9. Debtor days Trade debtorsDebtor days = x 365 Revenue (sales) Example Example Revenue = £21,450k Revenue = £21,450k Trade receivables = £4,030k Trade receivables = £4,030k Debtor days = 68.6 days Debtor days = 68.6 days
  10. 10. Evaluating debtor days• Interpreting the results: – Shows the average time customers take to pay – Each industry will have a “norm” – Need to take account of terms & conditions of sale – The important data is any significant change• Look out for – Comparisons (good or bad) v competitors – Balance sheet window-dressing
  11. 11. Creditor days Trade payablesCreditor days = x 365 Cost of sales Example Example Cost of sales = £13,465k Cost of sales = £13,465k Trade payables = £2,310k Trade payables = £2,310k Creditor days = 62.6 days Creditor days = 62.6 days
  12. 12. Evaluating creditor days• Interpreting the results – In general, a higher figure is better – Ideally, creditor days is higher than debtor days – Be careful: a high figure may suggest liquidity problems• Look out for: – Evidence from the current ratio or acid test ratio that business has problems paying creditors – Window-dressing: this is easiest figure to manipulate
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