In this blog, I will be discussing efficiency ratios. Efficiency ratios are used internally to check if the company is utilizing their assets and liabilities efficiently in earning revenues. Efficiency ratios are mainly used to assess how well assets and liabilities are utilized and managed. Following are some of the key ratios that one can use to analyze the performance of the company.

Accounts Receivable Turnover
Mostly every company provides services to their customers and let them pay in near future based on their credit policies. Companies with low turnover show that company is granting credit easily than other companies in similar industry or having a hard time in collecting the receivables from their customers. The ratio can be calculated as:
Accounts receivable turnover = Revenue / Average accounts receivable
Accounts receivable turnover = 500,000 / 20,000 = 25

Average Collection Period
This number measures how long company takes to collect its receivables from their customers. The less day’s company takes to collect receivables shows that customers are paying within their payment terms. A longer collection period shows that company has more of its revenue tied up in amounts owed from customers and a less efficient generation of cash flow. The collection period can be calculated as:
Average collection period = 365 days / Accounts receivable turnover
Average collection period = 365/25 = 14.6 Days

Accounts Payable Turnover
This ratios show if the company has enough resources to pay their liabilities to the suppliers or vendors. Companies with high turnover show that the company does not have strong payment terms with its suppliers and vendors. This ratio can be calculated as:
Accounts Payable Turnover = Cost of sales or service cost / Average accounts payable
Accounts Payable Turnover = 350,000 / 50,000 = 7

Average payment period
This ratio measure how long a company takes to pay its debt to their suppliers or vendors. The more days company takes to pay its liabilities shows that they get good terms on payment thus have more cash flow in hand. Conversely, a long payment period could be an indication that a company is having a problem paying its bills in a timely fashion. This ratio can be calculated as:
Average Payment Period = 365 days / Accounts payable turnover
Average Payment Period = 365/7 = 52 Days

Total Asset Turnover
This ratio measures how efficiently assets of the company are used to generate revenues. This ratio includes both short term and long term assets. Company with high asset turnover means that the company is earning more revenue for each dollar invested in assets. This ratio can be calculated as:
Total Asset Turnover = Revenue / Average total assets
Total Asset Turnover = 500,000 / 1,500,000 = 0.33

Return on Investment
This ratio shows how much income company earns against the money invested. Therefore, company with higher return is more profitable. For example, return of 20% can be interpreted as for each dollar invested, company is earning 20 cents on income before taxes. This ratio can be calculated as:
Return on investment = income before tax / investment
Return on investment = 200,000 / 1,000,000 = 20%

Fixed Asset Turnover
This ratio shows how much money has been invested in property, plant, and equipment (PP&E) together knows as fixed asset. Company with low ratio shows that the company has invested less money in fixed assets per dollar in revenue. Higher ratio shows that too much money has been invested in fixed assets. Ratio high or low depends upon the industry in which company does business. Professional companies will have low fixed asset ratio due to less fixed assets require performing operations. On the other hand construction companies will have higher fixed asset ratio they invest heavily in fixed assets. This ratio can be calculated as:
Fixed Asset Turnover = Revenue / Average fixed asset
Fixed Asset Turnover = 500,000 / 1,000,000 = 5%

Efficiency ratios are useful resources to cross check the performance of the company. It helps the management to take necessary steps if the ratios are not in favor as per the industry averages. A company should analyze the efficiency and performance ratios before making a decision of making high purchases, or changing receivable policies.