3.6 Efficiency Ratio Analysis (HL)

1. Which of the following is not an efficiency ratio?

   1. Debtor days 

   2. Creditor days

   3. ROCE

   4. Gearing

• 1. Debtor days 

• 1. Creditor days

• 1. ROCE

• 1. Gearing

Answer explanation

The answer is ROCE.

Debtor days and creditor days are both efficiency ratios. They measure how quickly a company is collecting its receivables and paying its payables, respectively. ROCE (return on capital employed) is a profitability ratio, while gearing is a financial risk ratio.

1. What do efficiency ratios access? 

• 1. The number of times a firm sells its inventory within a year 

• 1. A firm’s ability to meet its short term obligations

• 1. Profit as a proportion of sales revenue

• 1. How well a firm is utilizing its resources

Answer explanation

Efficiency ratios access how well a firm is utilizing its resources. They measure how effectively a company is using its assets to generate sales and profits. Some common efficiency ratios include:

• 1. Inventory turnover ratio: This ratio measures how many times a company sells its inventory within a year. A high inventory turnover ratio indicates that the company is efficiently using its inventory and generating sales.

• 2. Accounts receivable turnover ratio: This ratio measures how quickly a company collects its receivables. A high accounts receivable turnover ratio indicates that the company is collecting its receivables quickly and efficiently.

• 3. Asset turnover ratio: This ratio measures how efficiently a company is using its assets to generate sales. A high asset turnover ratio indicates that the company is using its assets effectively to generate sales.

Efficiency ratios can be used to compare a company's performance over time or to compare the performance of different companies. They can also be used to assess a company's financial health and to identify areas where the company could improve its efficiency.

1. What does the stock (inventory) turnover ratio measure?

• 1. 1. How many times a firm’s inventory is used per time period

• 2. How  many days it takes a firm to recover its accounts receivable (debtors) 

• 2. The value of all inventory sold per time period 

• 2. The total potential sales revenue that can be generated from selling all a firm’s inventory

Answer explanation

The stock (inventory) turnover ratio measures how many times a firm’s inventory is used per time period. It is calculated by dividing the cost of goods sold by the average inventory balance. A higher inventory turnover ratio indicates that the company is efficiently using its inventory and generating sales.

1. What is the formula for the stock turnover (in days)?

• 1. Cost of goods sold / average stock

• 1. Average stock /  cost of good sold x 365

• 1. Debt / sales revenue x 365

• 2. Cost of goods sold / average inventory x 365

1. With reference to the following data, what is the stock turnover (number of times per year) ratio?

• 1. 4.50 times

• 1. 5.40 times

• 1. 5.52 times

• 2. 6.75 times 

Answer explanation

With reference to the following data, what is the stock turnover (number of days) ratio?

• 1. 2.54 days

• 1. 76.20 days

• 1. 125.00 days

• 1. 143.44 days 

Answer explanation

Stock turnover ratio = $2,850,000 / $1,120,000 = 2.54

Therefore, the stock turnover (number of days) is:

Stock turnover (number of days) = 365 days / 2.54 = 143.44 days

Therefore, the stock turnover (number of days) ratio is 143.44.

I hope this helps! Let me know if you have any other questions.

7. Which of the following methods would not help improve a firm's stock turnover ratio?

• 7. a. Implementing a just-in-time stock management system

• 8. b. Divesting unpopular or obsolete items from the firm's product line

• 7. c. Hold lower stock levels

• 7. d. Hold greater stock levels

Answer explanation

The answer is d. Hold greater stock levels.

The other three methods, implementing a just-in-time stock management system, divesting unpopular or obsolete items from the firm's product line, and holding lower stock levels, will help improve a firm's stock turnover ratio.

• Just-in-time stock management is a system where inventory is only ordered when it is needed. This helps to reduce the amount of inventory that is sitting on the shelves, which can improve the stock turnover ratio.

• Divesting unpopular or obsolete items from the firm's product line will help to improve the stock turnover ratio by reducing the amount of inventory that is not selling.

• Holding lower stock levels will directly increase the stock turnover ratio.

Holding greater stock levels will have the opposite effect. A higher inventory level means that the company has more products sitting on the shelves that are not being sold. This will reduce the number of times that the inventory is sold in a given period, which will lower the stock turnover ratio.

Therefore, the answer is d. Hold greater stock levels.

8. Which of the following ratios measures the number of days it takes a firm to collect its debt from customers who have purchased on credit?

• 8. a. Credit days ratio

• 8. b. Collection days ratio

• 8. c. Acid test ratio

• 8. d. Debtor days ratio

Answer explanation

The answer is d. Debtor days ratio.

The debtor days ratio is a financial ratio that measures the average number of days it takes a firm to collect its debt from customers who have purchased on credit. It is calculated by dividing the average accounts receivable by the daily sales.

The other three ratios are not used to measure the number of days it takes a firm to collect its debt from customers who have purchased on credit.

9. What is the formula to calculate debtor days (in number of days)?

• 9. a. Average stock/ COGS x 365

• 9. b. Debt/Sales Revenue x 365

• 9. c. Creditors/ COGS x 365

• 9. d. Debt/COGS

What is the formula to calculate the creditor days ratio?

• a. Creditors/sales revenue x 365

• b. Capital employed / creditor days

• c. Creditors/ Debtors x 365

• d. Creditors/ COGS X 365