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Efficiency ratios

Efficiency ratios show how efficiently the business is using its resources. Shareholders in particular will want to know how well the firm is using their money! It is advisable for the business to get as much turnover from its assets as possible and at the same time it is not a good idea for it to have too many assets in the form of stock or debtors.

Financial efficiency can be examined by using the following ratios:

  • Return on capital employed
  • Asset turnover
  • Stock turnover
  • Debtor days

What do we mean by the term financial efficiency? A business uses capital - shareholders capital or that borrowed from the banks - to run its business. These stakeholders are entitled to know how well this capital is being used. In other words, is the company financially efficient? Are they growing the firm fast enough?

The last section showed how the acid test ratio could give an indication of financial performance. It only looked at the capital structure, though, and attempted to measure risk in some way. Other ratios are perhaps better at assessing performance, or use of money.

A firm uses capital to buy assets, stock and also 'lend' to its customers. How well it does this, may be checked by analysing the accounts.