Efficiency Formula

Efficiency Formula (Table of Contents)

• Formula
• Examples

What is the Efficiency Formula?

The term “Efficiency Formula” refers to the set of ratios that measure how well a company can utilize its assets and capital to generate revenue. In this article, we will discuss the following efficiency ratios:

1. Fixed Asset Turnover Ratio
2. Accounts Receivable Turnover Ratio
3. Inventory Turnover Ratio
4. Accounts Payable Turnover Ratio

The fixed asset turnover ratio formula can be expressed by dividing the company’s net sales by the average net fixed assets. Mathematically, it is represented as,

Efficiency Formula – Example #1

Let us take the example of Apple Inc.’s annual report for the year 2018 to illustrate the efficiency formula’s concept. Calculate the efficiency ratios for the year 2018 based on the below-given information.

Solution:

Average Net Fixed Assets is calculated using the formula given below

Average Net Fixed Assets = (Opening Net Fixed Asset + Closing Net Fixed Asset) / 2

• Average Net Fixed Assets = ($33,783 million + $41,304 million) / 2
• Average Net Fixed Assets = $37,543.5 million

Average Accounts Receivable is calculated using the formula given below

Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable) / 2

• Average Accounts Receivable = ($17,874 million + $23,186 million) / 2
• Average Accounts Receivable = $20,530 million

Average Inventory is calculated using the formula given below

Average Inventory = (Opening Inventory + Closing Inventory) / 2

• Average Inventory = ($4,855 million + $3,956 million) / 2
• Average Inventory = $4,405.5 million

Average Accounts Payable is calculated using the formula given below

Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable) / 2

• Average Accounts Payable = ($44,242 million + $55,888 million) / 2
• Average Accounts Payable = $50,065 million

Fixed Asset Turnover is calculated using the formula given below

Fixed Asset Turnover = Net Sales / Average Net Fixed Assets

• Fixed Asset Turnover = $265,595 million / $37,543.5 million
• Fixed Asset Turnover = 7.07

Accounts Receivable Turnover is calculated using the formula given below.

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable

• Accounts Receivable Turnover = $265,595 million / $20,530 million
• Accounts Receivable Turnover = 12.94

Inventory Turnover Ratio is calculated using the formula given below

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

• Inventory Turnover Ratio = $163,756 million / $4,405.5 million
• Inventory Turnover Ratio = 37.17

Accounts Payable Turnover is calculated using the formula given below

Accounts Payable Turnover = Cost of Goods Sold / Average Accounts Payable

• Accounts Payable Turnover = $163,756 million / $50,065 million
• Accounts Payable Turnover = 3.27

Explanation

The Efficiency Formula can be calculated by using the following steps:

Step 1: Firstly, determine the company’s net sales during the given period of time.

Step 2: Next, determine the cost of goods sold which is the aggregate of all the directly assignable cost of production, primarily raw material cost and direct labor cost. It is also reported as a cost of sales in many income statements.

Step 3: Next, determine the average net fixed assets, which are the average of the net fixed assets at the beginning and at the end of the period. The net fixed asset is gross block minus accumulated depreciation.

Average Net Fixed Assets = (Opening Net Fixed Asset + Closing Net Fixed Asset) / 2

Step 4: Next, determine the average accounts receivable, which are the average of the accounts receivable at the beginning and at the end of the period.

Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable) / 2

Step 5: Next, determine the average inventory, which is the average of the inventory at the beginning and at the end of the period.

Average Inventory = (Opening Inventory + Closing Inventory) / 2

Step 6: Next, determine the average accounts payable, which is the average of the accounts payable at the beginning and at the end of the period.

Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable) / 2

Step 7: Therefore, the formula for the fixed asset turnover ratio can be derived by dividing the net sales (step 1) by the average net fixed assets (step 3), as shown below.

Fixed Asset Turnover = Net Sales / Average Net Fixed Assets.

Step 8: Therefore, the formula for the accounts receivable turnover ratio can be derived by dividing the net sales (step 1) by the average accounts receivable (step 4), as shown below.

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable

Step 9: Therefore, the formula for inventory turnover ratio can be derived by dividing the cost of goods sold (step 2) by the average inventory (step 5), as shown below.

Inventory Turnover = Cost of Goods Sold / Average Inventory.

Step 10: Therefore, the formula for the accounts payable turnover ratio can be derived by dividing the cost of goods sold (step 2) by the average accounts payable (step 6), as shown below.

Accounts Payable Turnover = Cost of Goods Sold / Average Accounts Payable

Relevance and Use of Efficiency Formula

A business needs to understand the concept of efficiency ratios because these ratios are used to judge the capability of the management. Efficiency ratios primarily measure the time a company takes to collect its receivables from the customer or convert inventory into revenue or the return generated on the invested capital. A comparison of the efficiency ratio with the industry benchmarks can provide useful insights about a company’s operation.

Recommended Articles

This is a guide to the Efficiency Formula. Here we discuss how to calculate the Efficiency Formula along with practical examples. We also provide a downloadable excel template. You may also look at the following articles to learn more –

1. How to Calculate Bank Efficiency Ratio?
2. Inventory Turnover Ratio Calculator
3. Example in Accounts Payable Turnover Ratio
4. Calculation in Accounts Receivable Turnover Ratio
5. Guide to Asset Turnover Ratio