Measuring Efficiency

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Efficiency

Measures of activity include:

  1. Accounts receivable collection period

  2. Accounts payable payment period

  3. Inventory  turnover period

Accounts receivable collection period

  • This is a measure of management’s efficiency and is expressed as:

    Receivables 
    --------------         x 365 days
    Sales

                      
    This is an indicator of the effectiveness of the company’s credit control systems and policy.

Accounts payable payment period

  • The creditor days is a measure of how much credit, on average, is taken from suppliers. It is expressed as:

    Trade Payables   
    ---------------------    x 365 days
    Purchases

    This ratio is an aid to assessing company liquidity, as an increase in creditor days is often a sign of inadequate working capital control.

Inventory turnover period

  • This is expressed as: 

    Inventory   
    --------------------  x 365 days
    Cost of sales

The holding period may increase because of:

  1. Build-up of inventory levels as a result of increased capacity following expansion of non-current assets.

  2. Increasing inventory levels in response to increased demand for product.

Illustration

Receivables $10,000
Inventory $15,000
Payables $12,000
Credit sales $30,000
COS $20,000

What are the receivables days?

10,000/30,000 * 365 days = 121.7 days

What are the payables days?

12,000/20,000 * 365 days = 219 days

What the inventory days?

15,000/20,000 * 365 days = 273.8 days 

Looks like the company is not managing its working capital well!

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