Efficiency Ratio:

 Efficiency Ratio: Definition, Formula, types and Example


Efficiency ratio is a measure of the operating efficiency of a business. It is calculated by dividing operating expenses by net sales. The higher the efficiency ratio, the less efficient the company is considered to be.


Formula: Efficiency ratio = Operating Expenses / Net Sales


Types of Efficiency Ratios


1. Asset Turnover Ratio: This measures the efficiency of a company's use of its assets to generate sales. It is calculated by dividing the net sales by the average total assets.

2. Inventory Turnover Ratio: This measures how quickly a company is able to convert its inventory into sales. It is calculated by dividing the cost of goods sold by the average inventory.

3. Accounts Payable Turnover Ratio: This measures how quickly a company is able to pay its suppliers. It is calculated by dividing accounts payable by the average accounts payable.

4. Operating Expense Ratio: This measures the efficiency of a company's operations. It is calculated by dividing operating expenses by total sales.


Example:


Company ABC has the following financial information for the year 2020:


Net sales: $1,000,000

Operating expenses: $200,000

Average total assets: $800,000

Cost of goods sold: $600,000

Average inventory: $400,000

Accounts payable: $100,000

The efficiency ratios for Company ABC are:

Asset turnover ratio = 1,000,000 / 800,000 = 1.25

Inventory turnover ratio = 600,000 / 400,000 = 1.5

Accounts payable turnover ratio = 100,000 / 100,000 = 1.0

Operating expense ratio = 200,000 / 1,000,000 = 0.2


conclusion


Efficiency ratio is a measure of the operating efficiency of a business. It is calculated by dividing operating expenses by net sales. Different types of efficiency ratios measure different aspects of a company's operations, such as the efficiency of its use of assets, its ability to convert inventory into sales, and its ability to pay suppliers.

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