Efficiency ratios show how well a business handles its stock and its credit. The three you need are stock turnover, debtors collection period and creditors payment period.
This lesson follows calculating liquidity ratios.
What are the formulas?
| Ratio | Formula | Result is in |
|---|---|---|
| Stock turnover | Cost of sales ÷ Average stock | times |
| Debtors collection period | Debtors ÷ Credit sales × 365 | days |
| Creditors payment period | Creditors ÷ Credit purchases × 365 | days |
Average stock is (opening stock + closing stock) ÷ 2.
Worked example: a fictional wholesaler
An original set of figures, in RM.
| Item | Amount |
|---|---|
| Cost of sales | 120 000 |
| Opening stock | 18 000 |
| Closing stock | 22 000 |
| Debtors | 15 000 |
| Credit sales | 146 000 |
| Creditors | 10 000 |
| Credit purchases | 73 000 |
Stock turnover. Average stock = (18 000 + 22 000) ÷ 2 = 20 000. Turnover = 120 000 ÷ 20 000 = 6 times.
Debtors collection period. 15 000 ÷ 146 000 × 365 = 37.5 days.
Creditors payment period. 10 000 ÷ 73 000 × 365 = 50 days.
What they say. The wholesaler turns its stock over 6 times, about once every 61 days. Customers pay in 37.5 days and the wholesaler pays suppliers in 50 days. It collects cash 12.5 days before it has to pay suppliers, which helps cash flow.
The mistake that costs marks
The slip is to use closing stock only, or to use total sales instead of credit sales. Both give a tidy number, and both are wrong.
| Step | Wrong | Right |
|---|---|---|
| Stock turnover | 120 000 ÷ 22 000 = 5.5 times | 120 000 ÷ 20 000 = 6 times |
| Stock figure | Closing stock | Average stock |
| Collection period | Uses total sales | Uses credit sales |
Read the question for “average” and for the word “credit”.
Check yourself
Cost of sales is 91 000, opening stock 12 000 and closing stock 16 000. Debtors are 9 000 and credit sales are 73 000. Find stock turnover and the collection period.
Answer
Average stock = (12 000 + 16 000) ÷ 2 = 14 000. Turnover = 91 000 ÷ 14 000 = 6.5 times.
Collection period = 9 000 ÷ 73 000 × 365 = 45 days.
A comment: customers take 45 days to pay, so the business should check whether its credit terms are being followed.
What to study next
Go to comparing businesses without ignoring context. Keep track of your own slips in the mistake log.
If you want a teacher to practise comments with you, see online one-to-one Accounting tuition.