Efficiency Ratio Formula (Table of Contents)
What is the Efficiency Ratio Formula?
The efficiency ratio of a company measures how the company manages and used its assets internally. The efficiency can be calculated by measuring the turnover of payables, receivables, usage of equity, debt and machinery. Efficiency ratios are also used to analyze the performance of various investment, retail and commercial banks. This ratio measures how well the company is using its assets. This ratio translated the efficiency in profitability. This ratio is also used in comparative analysis to measure how the company is performing in comparison to its peers.
Few of the vital efficiency ratios are listed below:
Examples of Efficiency Ratio Formula (With Excel Template)
Let’s take an example to understand the calculation of the Efficiency Ratio in a better manner.
Efficiency Ratio Formula – Example #1
Let us look at a comprehensive example and calculate the important efficiency ratios based on the income statement and balance sheet of ABC limited.
Solution:
Using the above statements let us now calculate the efficiency ratios –
Total Asset Turnover is calculated as
Total Asset Turnover = Total Sales / Total Assets
- Total Asset Turnover = $4,30,000 / $40,10,907
- Total Asset Turnover = 0.11x
Total Assets to Sales is calculated as
Total Assets to Sales = Total Assets / Total sales
- Total Assets = $40,10,907 / $4,30,000
- Total Assets = 9.33
Fixed Assets to Total Assets = Fixed Assets / Total Assets
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- Fixed Assets to Total Assets = $3,15,299 / $40,10,907
- Fixed Assets to Total Assets = 7.86%
Efficiency Ratio Formula – Example #2
Let us now look at an example of a few turnover ratios
Solution:
Farm Supply Inventory Turnover is calculated as
Farm Supply Inventory Turnover = Farm Supply COGS / Farm Supply Inventory
- Farm Supply Inventory Turnover = $3,70,000 / $3,82,982
- Farm Supply Inventory Turnover = 0.97
Average Farm Supply Sales Outstanding is calculated as
Average Farm Supply Sales Outstanding = Accounts Receivable / (Sales / 360)
- Average Farm Supply Sales Outstanding = $ 470527 / ($370000 / 360)
- Average Farm Supply Sales Outstanding = 457.81
Efficiency Ratio Formula – Example #3
Now that we have calculated all the important ratios. Let us use see how ABC ltd is performing in comparison to its peers
Solution:
The total asset turnover ratio of ABC Ltd is much less than that of peers > 4 to 5 while the total assets to sales ratio are 9.33 which falls in line with the peers. The farm supply inventory turnover is 0.97 which is lower than the industry average of 7 to 10. While the Average Farm Supply Sales Outstanding is much higher than its peers and states how long the company takes to collect its payment once sales have been completed.
Explanation
The formula for efficiency ratio cost can be derived by using the following steps:
Step 1: In calculating the efficiency ratio we need to pick numbers from the income statement and balance sheets.
Step 2: Based on which ratio you want to calculate, use the numbers and put them in the formula.
Step 3: After the numbers are input, we divide them and come to a formula.
Relevance and Use of Efficiency Ratio Formula
This ratio is of particular importance to the investors, and they use it to measure the performance of the company. Keeping the profitability, aside this ratio measures the efficiency of the company and how efficiently the company is using its assets. This ratio helps the investors understand how the company is performing and making profits with what it has and the ability of the company to use its long term assets.
One more vital point of the efficiency ratio is that it is very easy to calculate and all the numbers can be easily found from the financial statements (income statement and balance sheet). One of the popularly used metrics is the asset turnover ratio and a more refined metric of this is the fixed asset turnover ratio.
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This is a guide to the Efficiency Ratio Formula. Here we discuss how to calculate Efficiency Ratio along with practical examples. We also provide a downloadable excel template. You may also look at the following articles to learn more –
