Efficiency Ratios: Measuring How Well a Company Uses Its Resources
Efficiency ratios reveal how effectively a company uses its assets and manages its operations. While profitability and solvency tell you what a company earns and how it funds itself, efficiency ratios uncover how it gets there. Asset Turnover Ratio
Formula: Revenue / Total Assets
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Indicates how efficiently a company uses its total assets to generate sales.
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Higher is generally better but varies heavily by industry.
Example:
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Walmart may have an asset turnover of 2.5, while Apple could be around 0.8 due to large cash balances and long-term assets.
2. Inventory Turnover Ratio
Formula: Cost of Goods Sold (COGS) / Average Inventory
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Measures how often inventory is sold and replaced.
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Higher turnover implies efficient inventory management.
Example:
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A grocery store may have a turnover of 12 (monthly turnover), while a luxury retailer may be closer to 2 or 3.
3. Days Inventory Outstanding (DIO)
Formula: (Average Inventory / COGS) × 365
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Shows how many days inventory remains before it is sold.
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Inverse of inventory turnover.
Tip: Lower DIO = better inventory management (sector dependent)
4. Receivables Turnover Ratio
Formula: Net Credit Sales / Average Accounts Receivable
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Indicates how quickly a company collects from customers.
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Higher turnover means faster collections and stronger cash flow.
Example:
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SaaS businesses may have a receivables turnover of 6–8, while industrial firms may be 4–6.
5. Days Sales Outstanding (DSO)
Formula: (Accounts Receivable / Revenue) × 365
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Reveals how many days it takes to collect a payment after a sale.
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Lower DSO = faster cash recovery.
Example:
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Company A has DSO of 30 (monthly billing), while Company B has DSO of 60 (delayed B2B invoicing).
6. Payables Turnover Ratio
Formula: COGS / Average Accounts Payable
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Measures how quickly a company pays suppliers.
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Lower turnover can indicate supplier negotiation strength—or liquidity stress.
7. Days Payable Outstanding (DPO)
Formula: (Accounts Payable / COGS) × 365
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Shows the average number of days a company takes to pay its bills.
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High DPO can improve working capital but may strain supplier relationships.
The Cash Conversion Cycle (CCC)
Formula: CCC = DIO + DSO – DPO
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Measures how long cash is tied up in operations.
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Lower CCC = better working capital efficiency.
Example:
A company with DIO = 40, DSO = 35, DPO = 30 → CCC = 45 days. It takes 45 days to convert investment in inventory back into cash.
Market Phase Interpretation
📈 Bull Market
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Efficiency may be overlooked if revenue is rising.
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But high-growth firms are rewarded for shortening DSO/DIO to reinvest faster.
📉 Bear Market
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Investors scrutinize working capital cycles.
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Companies with long CCCs or rising DIO/DSO may face pressure.
✨ Recovery or Transition Phase
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Operational discipline returns to focus.
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Falling DIO and DSO signal better execution.
Sector Benchmarks (Typical Ranges)
Practical Red Flags
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Rising DIO or DSO without revenue growth → inefficiency
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DPO falling in a bear market → less negotiating power or liquidity stress
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CCC extending over time → cash flow pressure
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Mismatch: DSO increasing while revenue declines = potential collection problems
Case Study: Two Retail Companies
Company A (Efficient Retailer)
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Inventory Turnover: 13
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DSO: 20 days
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DPO: 60 days
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CCC: -27 days
Company A gets paid by customers before it pays suppliers—negative CCC = strong cash cycle.
Company B (Struggling Retailer)
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Inventory Turnover: 5
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DSO: 45 days
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DPO: 25 days
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CCC: 65 days
Cash is tied up for over two months
