Efficiency ratios are essential tools for calculating the financial effectiveness of a business. Thankfully, the calculations you have to perform are pretty straightforward, and can be completed accurately and easily with the help of a calculator. Learning most important ratios which are used to measure the financial success of a business helps you objectively analyse your organisation and can help A-level students with business studies classes. The main ratios to calculate are the asset turnover ratio, the stock turnover ratio and the debtor days ratio.
- Skill level:
- Moderately Easy
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Things you need
- Financial data for business
Determine the ratios you wish to calculate. The asset ratio tells you how much revenue you bring in per £1 of assets held, and to calculate it you need to know your business’ net assets and sales revenue. The debtor days ratio tells you how long it takes a business to claim the funds owed by customers who make purchases on credit, and to work it out you’ll need the total figure owed by debtors and the sales turnover for the business. Finally, the stock turnover ratio tells you how many times the business sells its stock over the course of a year, and is calculated using the annual revenue from goods sold and the value of a full load of stock. You can work out all of these figures to get a sense of the position of the business.
Divide the business’ sales revenue by the net value of the assets held if you want to work out the asset turnover ratio. For example, if the annual sales revenue is £9 million and the net assets total £6 million, 9,000,000 ÷ 6,000,000 = 1.5 (in this situation, you could simply divide 9 by 6 to obtain the same result, completing the calculation in “millions” of units). In this situation, the business would take £1.50 in revenue for every £1 of assets.
Divide the total owed by debtors by the sales turnover if you want to determine the debtor days ratio. For example, if the business is owed £1.5 million by debtors, but has an annual sales turnover of £10 million, you complete the calculation: 1.5 million ÷ 10 million = 0.15. Turn this into the final figure by multiplying the result by 365. For the example: 0.15 × 365 = 54.75. This is a number of days, so you can round it up to the next figure if the first decimal number is a 5 or higher – making 55 the rounded answer for the example. This means that it takes the business an average of 55 days to collect debts.
Use the figures for revenue from goods sold and the value of a full stock to determine the stock turnover of the business. You divide the revenue from goods sold by the value of a full stock to find the answer. For example, if the business takes in £3.5 million in revenue and a full stock is valued at £0.7 million, you calculate (in millions): 3.5 ÷ 0.7 = 5. This means that the business works through its stock five times per year. Divide 365 by the result to find out how many days that translates to. In the example, the business works through its stock every 73 days.
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