Efficiency ratios are various types of ratios that determine how well a company uses its assets and resources to make a profit. Different types of efficiency ratios include the accounts receivable and accounts payable turnover ratios, the inventory turnover ratio and the average collection periods.
Efficiency ratios are beneficial for both the company itself and investors. Businesses themselves often calculate and analyze efficiency ratios to see how well they are doing in managing their assets and gaining income. If the ratios are low, this means that changes need to be made within the company. Similarly, investors look at efficiency ratios to evaluate how well a company is being managed. This helps the investors know which companies are worth investing into and which companies will use investments most efficiently to increase revenue.
The accounts receivable and accounts payable turnover ratios determine how quickly the company gets the money that is owed to them, and how quickly the company pays their bills. A low accounts receivable turnover ratio indicates that the company does not manage their debtors as well as a company with a high ratio does. The inventory turnover ratio identifies how efficient the company is at keeping inventory and selling it. If there is a low inventory turnover ratio, this could mean that the company does not manage their inventory well and has a lot of lost money in unused inventory sitting on the shelves.