financial-efficiency-ratios

The meaning and importance of financial efficiency

• Financial efficiency is a measure of how well a business utilises its assets and liabilities to generate sales and maximise profits 

• Efficiency ratios provide insights, including

  • How well stocks are being managed

  • The time taken for a business to settle debts with its creditors

  • How well credit offered to customers is being controlled

Why financial efficiency is important

• Improves profitability

  • Efficient use of resources, like controlling costs or managing inventory, helps increase profit margins

• Supports cash flow management

  • Financial efficiency ensures a business can pay its bills on time and avoid cash shortages

• Boosts competitiveness

  • A financially efficient business can keep prices lower or invest more in quality and innovation, giving it a competitive edge over rivals

Inventory turnover

• The inventory turnover ratio shows how well a business converts its stock into sales

• Before calculating inventory turnover, it is first necessary to calculate the average value of stock held by a business in a given period

  • It is calculated using the formula

Calculating the inventory turnover ratio

• Inventory turnover can then be calculated in two ways

1. The number of times

• The number of times a business sells all of its stock during a period (usually a year)

• Businesses aim for a high or increasing ratio

  • More stock sold means that it is generating profit more efficiently

  • Perishable goods are less likely to be wasted

2. The number of days

2. The number of days taken to sell all of its stock

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