Efficiency ratios reveal how effectively a company uses its assets and manages its operations. While profitability and solvency tell you what a company earns and how it funds itself, efficiency ratios uncover how it gets there. These metrics are particularly useful for comparing operational quality across competitors, uncovering bottlenecks, or spotting deteriorating business practices before they hit the income statement.
What Are Efficiency Ratios?
They are most valuable when viewed as trends over time or benchmarked against peers.
1. Asset Turnover Ratio
Indicates how efficiently a company uses its total assets to generate sales.
Example:
2. Inventory Turnover Ratio
Measures how often inventory is sold and replaced.
Example:
3. Days Inventory Outstanding (DIO)
Shows how many days inventory remains before it is sold.
Tip: Lower DIO=better inventory management (sector dependent)
Formula: Net Credit Sales / Average Accounts Receivable
Higher turnover means faster collections and stronger cash flow.
SaaS businesses may have a receivables turnover of 6–8, while industrial firms may be 4–6.
Formula: (Accounts Receivable / Revenue) × 365
Lower DSO=faster cash recovery.
Company A has DSO of 30 (monthly billing), while Company B has DSO of 60 (delayed B2B invoicing).
Formula: COGS / Average Accounts Payable
Lower turnover can indicate supplier negotiation strength—or liquidity stress.
Formula: (Accounts Payable / COGS) × 365
High DPO can improve working capital but may strain supplier relationships.
Formula: CCC=DIO + DSO – DPO
Lower CCC=better working capital efficiency.
Example: A company with DIO=40, DSO=35, DPO=30 → CCC=45 days. It takes 45 days to convert investment in inventory back into cash.
? Bull Market
But high-growth firms are rewarded for shortening DSO/DIO to reinvest faster.
Investors scrutinize working capital cycles.
✨ Recovery or Transition Phase
Falling DIO and DSO signal better execution.
Practical Red Flags
DPO falling in a bear market → less negotiating power or liquidity stress
Mismatch: DSO increasing while revenue declines=potential collection problems
Company A (Efficient Retailer)
DSO: 20 days
CCC: -27 days
Company B (Struggling Retailer)
DSO: 45 days
CCC: 65 days
Tips for Analyzing Efficiency Ratios
Always benchmark by sector.
Use in combination with cash flow metrics.
We at ForexLive.com (evolving to investingLive.com later this year) are continuing to educate investors. In this case, understanding efficiency ratios empowers you to assess whether a company is turning assets and operations into growth—or wasting time and capital.
Efficiency isn’t just about doing more—it’s about doing it smarter and faster.
This article was written by Itai Levitan at www.forexlive.com. Read More Details
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