Essential Business Formulas - Efficiency Ratios

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If you've been in business before, you know how important efficiency is to the success of any company. Efficiency ratios measure efficiency with inventories, accounts receivable, fixed assets, and total assets. They allow you to judge how well your business is using its assets and determine if changes can be made. These ratios are very helpful in your business plan for showing investors how efficient your business operates.

Average Inventory Investment Period
The Average Inventory Investment Period measures the number of days it takes to convert the money you invest in inventory into sales.

Formula: [Current Inventory Balance / (Annual Cost of Goods Sold / 360)]

Inventory to Sales Ratio
This ratio measures quickly shows you recent changes in inventory levels by comparing the inventory level to sales. Keeping track of this ratio and comparing it month to month can help you important avoid future cash flow problems.

Formula: [Inventory at End of Month / Sales for the Month]

Inventory Turnover
This formula will show you the number of days it takes to turn over your entire inventory. This is a good indication of whether or not you are stocking the right amount of inventory. Low turnover can indicate low sales, while a high turnover can indicate strong sales or purchasing problems.

Formula: [Sales / Inventory] or [Cost of Goods Sold / Average Inventory]

Average Collection Period
The average collection period measures the amount of time it takes to convert your accounts receivable into cash. The longer it takes for you to collect your receivables, the less cash you have to pay your bills.

Formula: [Current Account Receivables Balance / (Annual Sales / 360)]

Accounts Receivable to Sales Ratio
This ratio compares your accounts receivable to sales each month. Monitoring changes in this ratio from month to month is a good way to avoid cash flow problems in the future because growth of this ratio indicates that your cash is decreasing. An increase in this ratio from one month to the next indicates that your accounts receivable is growing faster than your sales.

Formula: [Accounts Receivable / Sales for Month]

Fixed Asset Turnover
The Fixed Asset Turnover is the ratio of sales to fixed assets. It shows how well your business is using its fixed assets to generate sales. A declining ratio may indicate that your investment in fixed assets is too high.

Formula: [Sales / Fixed Assets]

Total Asset Turnover
The Total Asset Turnover compares sales to total assets and shows you how well you are using all of your assets to generate revenue for your business. If you have a high total asset turnover, you probably have a low profit margin.

Formula: [Sales / Total Assets]
Continue to Profitability Ratios

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