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Efficiency Ratios And Their Importance
by Whiz Consulting Accounting and Bookkeeping ServiceFinancial statements alone cannot provide complete information to the investors about an organisation. The numbers in the statements need to be put into context to understand different aspects of the business operations better. One of the methods is ratio analysis in accounting which helps investors gain a good understanding. Ratio analysis is the quantitative method to look into a business's efficiency, revenues, liquidity and profitability by analysing its financial statements and records. The comparative analysis provides insights into the business performance over the years. It facilitates intra-company as well as inter-company comparison within the same sector.
There are different types of financial ratios as per their relevance for a particular organisation. The types of ratios can be classified as profitability ratios, efficiency ratios, liquidity ratios, leverage ratios and market ratios. Each type of ratio enables businesses to measure important aspects of their businesses. Managers can also utilise the ratios to understand the strengths and weaknesses of their organisation. To know more in detail, let us learn about the efficiency ratios and their importance.
What Are Efficiency Ratios?
Efficiency ratios are used to analyse the ability of a business to employ its resources to generate income. Also known as activity ratios, they compare expenses and revenues generated and highlight how much or kind of return is generated from the amount spent on the operations. A business's efficiency is judged by effective management and smooth operations. This helps to generate maximum profitability in the long run. In totality, efficiency ratios serve as an important measure of the current and short-term business performance.
Some examples of efficiency ratios are:
- Inventory turnover ratio
- Accounts payable turnover ratio
- Accounts receivable turnover ratio
- Asset turnover ratio
Importance of efficiency ratios
Effective management of assets and resources directly affects the sales and profits in a business. The better the management of assets, the higher is the sales and profits. A measure that indicates the efficiency or effectiveness with which a business manages its assets or resources is known as the efficiency ratio. Efficiency ratios help an organisation to understand whether the business is making the best possible use of its resources or not. There is a high correlation between efficiency and profitability ratios because when businesses allocate their resources efficiently, they become more profitable.
Efficiency ratios are vital for the management of a business to evaluate its operations. Investors can use these ratios to make well-informed investment decisions. They can get an idea of whether a business represents a good investment or a creditworthy borrower or not. Also, the internal management can analyse how the company has been performing for a while. This facilitates a comparison of past and current business performances. Thus, efficiency ratios are a perfect measure to analyse the effectiveness of a business and its operations.
A financial ratio is a reliable method to know about an organisation for internal and external purposes. But, since businesses are preoccupied with significant business activities, it becomes challenging to perform business analysis. Thus, companies can outsource the process of financial analysis with other business processes like virtual bookkeeping services, payroll management, etc.
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Accounting and Bookkeeping Service
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Created on Jun 28th 2022 03:29. Viewed 97 times.
