Important performance ratios that you must calculate at regular intervals in order to assess how well your resources are utilized and measure the business’s performance over a given time.
Investopedia defines Performance Ratios as, ‘These ratios look at how well a company turns its assets into revenue as well as how efficiently a company converts its sales into cash’
Performance ratios help in:
Gauging how efficiently and effectively a company is using its resources to generate sales
Determining the growth of the promoter’s investment
Measuring how individual aspects of a business are performing The important performance ratios are:
- Gearing ratio shows the balance between debt and equity in the business
- It is calculated as total borrowings divided by net worth of the business
- It is important to maintain a healthy balance between borrowings and owner’s capital, with owner’s capital being higher than debt in order to carry on business operations independently and away from the daily scrutiny of creditors
Debtors Turnover Ratio:
- Debtors turnover ratio indicates the number of times your debtors pay you over a year
- It gives you insight into the time of cash flow from credit sales
- Debtors Turnover is calculated as Net Credit Sales divided by Average Trade Debtors
- If the debtors turnover is high, it means you are getting paid more frequently. Say, if it is 6, it means that you are collecting your sales once every 2 months.
On the other hand, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors.
Creditors Turnover Ratio:
- Creditors Turnover Ratio, on the other hand, shows the number of times you make payments to your suppliers.
- It is calculated as Purchases divided by Average Trade Creditors.
- A high creditors turnover ratio signifies that the creditors are being paid promptly. This shows that your business is highly creditworthy. However a very favorable ratio to this effect also shows that your business is not taking full advantage of credit facilities allowed by the creditors.
Stock Turnover Ratio:
- This ratio measures how fast the inventory in your business is moving and generating sales
- It is calculated as Cost of Good Sold/ Average Stock
- A higher ratio will indicate a slow-moving inventory while too low a ratio will mean that your business is not able to manage stock levels to meet sales demands