Efficiency ratios Cambridge IGCSE Accounting (9–1) revision
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In plain words
Efficiency ratios measure how quickly things move: how fast inventory is sold, how long customers take to pay, and how long the business takes to pay its suppliers.
7 things to know
- Rate of inventory turnover (times) = cost of sales ÷ average inventory. Average inventory = (opening inventory + closing inventory) ÷ 2.
- Inventory turnover (days) = average inventory ÷ cost of sales × 365.
- Trade receivables turnover (days) = trade receivables ÷ credit sales × 365. It is the average time customers take to pay.
- Trade payables turnover (days) = trade payables ÷ credit purchases × 365. It is the average time the business takes to pay its suppliers.
- Selling inventory faster is better: more times, or fewer days. Customers paying sooner is better.
- Taking longer to pay suppliers helps cash flow, but taking too long may lose cash discounts and the suppliers' goodwill.
- Answers in days are rounded up to the next whole day.
Worked example
Cost of sales is $120 000. Inventory was $14 000 at the start of the year and $16 000 at the end. Trade receivables are $9000 and credit sales are $109 500. Calculate the rate of inventory turnover and the trade receivables turnover.
- Average inventory = (14 000 + 16 000) ÷ 2 = $15 000.
- Rate of inventory turnover = 120 000 ÷ 15 000 = 8 times.
- Trade receivables turnover = 9000 ÷ 109 500 × 365 = 30 days.
Tips and tricks
- Inventory is at cost, so it is compared with cost of sales, never with revenue.
- Use credit sales and credit purchases only. Cash sales produce no trade receivables.
It lands in your notebook with its questions as flashcards.
Efficiency ratios: 5 questions and answers
These are the quiz’s questions. Do the quiz first, then come back here for the ones that got you.
How is the rate of inventory turnover calculated?
Both figures are at cost.
Opening inventory is $6000 and closing inventory is $8000. What is the average inventory?
(6000 + 8000) ÷ 2.
Trade receivables $5000, credit sales $73 000. What is the trade receivables turnover?
5000 ÷ 73 000 × 365.
The rate of inventory turnover rises from 6 times to 9 times. What does this show?
More times a year means each item spends less time on the shelf.
What does the trade payables turnover measure?
It uses trade payables and credit purchases.
Quiz
5 questions
Tap an answer and you’ll see straight away whether it’s right, and why.
Worksheet
3 questions, 6 marks. Write your answers on paper, then check them.
Efficiency ratios
Cambridge IGCSE Accounting (9–1) 0985 · 6 marks · papermunch.org
Name ______________________________ Date ______________
Cost of sales is $90 000 and average inventory is $7500. Calculate the rate of inventory turnover.[2]
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12 times. 90 000 ÷ 7500.
Trade payables are $8000 and credit purchases are $73 000. Calculate the trade payables turnover in days.[2]
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40 days. 8000 ÷ 73 000 × 365.
The trade receivables turnover has risen from 28 days to 45 days. Suggest two actions the business could take.[2]
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Offer cash discount for prompt payment. Send statements and reminders more promptly. (Also: charge interest on overdue accounts.)
Answers: Efficiency ratios
- 1. 12 times. 90 000 ÷ 7500.
- 2. 40 days. 8000 ÷ 73 000 × 365.
- 3. Offer cash discount for prompt payment. Send statements and reminders more promptly. (Also: charge interest on overdue accounts.)