What Do Efficiency Ratios Measure?

Efficiency indicators measure a company’s ability to use its assets effectively in the current period or in the short term and to manage its liabilities. While there are several efficiency metrics, they are similar in that they measure the time it takes to generate money or revenue from a customer, or to liquidate inventory.

Efficiency indicators include inventory turnover rate, system turnover rate and accounts receivable turnover rate. This metric measures how effectively a company uses its assets to generate revenue and how well it manages those assets. As with any other financial metric, it is best to compare a company’s relationship with its competitors in the same industry.

Read on to learn more about these three performance metrics and what they mean.

main conclusion

Efficiency metrics measure a company’s ability to use its assets effectively and manage its liabilities effectively.
The inventory turnover rate is used to determine whether there are enough sales to move or use up the inventory.
High turnover means the company uses its assets efficiently, while low turnover means that its assets are used inefficiently.
The receivables turnover rate measures the company’s efficiency in collecting receivables and increasing debt.

Inventory turnover rate
Inventory turnover rate measures a company’s ability to manage its inventory effectively and provides an overview of the company’s sales. The ratio measures the average number of times the total inventory has been sold in a given period. Analysts use metrics to determine whether enough sales are generated to transfer or use inventory. The ratio also reflects how well the stock is managed, including whether to buy too many shares.

The ratio is calculated by dividing the cost of goods sold by the average inventory.

For example, A is selling computers and the COGS is $5 million. Company A has an average inventory of $20 million. The company’s inventory turnover rate is 0.25 ($5M / $20M). This indicates that Company A did not manage its inventory well because it only sold a quarter of its inventory for the year.

Efficiency metrics can also monitor and analyze the performance of commercial banks and investment banks.

Asset turnover rate
The asset turnover ratio measures a company’s ability to effectively generate revenue from its assets. In other words, the Asset Turnover Ratio calculates sales as a percentage of the company’s assets. This ratio is effective in showing how many sales are made for each dollar of assets owned by the company.

The asset turnover rate is calculated annually.

A high turnover rate means management is using their assets more efficiently, while a lower rate means management is not using their assets effectively.

The ratio is calculated by dividing the company’s sales by its total assets. For example, suppose a company has net assets of $1,000,000 and revenue or revenue for the period is $300,000. The asset turnover rate is 0.30 ($300,000 / $1,000,000). In other words, the company makes 30 cents for every dollar of assets.

Accounts Receivable Turnover
Accounts receivable turnover rate measures how effectively a company can actively collect its receivables and improve its creditworthiness. The ratio is calculated by dividing the company’s net loan sales by its average claims.

For example, a company has an average receivable of $100,000 which is the average of the opening and closing balances for the period. Revenue for the period was $300,000, so the turnover rate is 3, which means the company has collected its receivables three times for the period.

In general, companies with high accounts receivable turnover rates are cheaper than their peers. The high level of fluctuation indicates that the company is more efficient than its competitors in terms of debt collection.