Efficiency ratios measure how effectively a business uses its assets and manages its operations. Asset turnover ratios, activity ratios and asset management ratios are all examples of efficiency ratios. Two important efficiency ratios applicable to most businesses are the fixed asset turnover ratio and the inventory turnover ratio.
Fixed Asset Turnover Ratio
The fixed asset turnover ratio measures how effectively a business uses fixed assets to create revenue. To calculate fixed asset turnover, divide sales revenue by total fixed assets. For example, a company with $10,000 in sales revenue and fixed assets with a book value of $5,000 has a fixed asset turnover ratio of 2. The higher the ratio, the more revenue the business can generate relative to its fixed assets.
Inventory Turnover Ratio
The inventory turnover ratio measures how long it takes for a business to cycle through all of its inventory. To calculate inventory turnover, divide cost of goods sold by the average amount of inventory during the period in question. Next, divide the number of days in the period by the inventory turnover. The higher the ratio, the longer it takes the business to sell inventory.