Efficiency Ratios
Efficiency and Turnover Ratios
This lesson connects inventory turnover, receivables turnover, payable days, asset turnover, working capital turnover, and the cash conversion cycle.
Concept First
Learn It Step By Step
Start with the business meaning, then move into the formula.
How should I read Inventory Turnover and Inventory Days?
Inventory Turnover asks how many times stock is sold or consumed during the year. If Company A has sales of Rs. 100, COGS of Rs. 80, and average inventory of Rs. 20, turnover is 4.0x and inventory days are about 91 days. Company B has the same sales and COGS but average inventory of Rs. 40, so turnover is 2.0x and days are about 183 days. A is better because it generates the same business with less stock blocked, assuming it is not losing sales due to stock-outs.
How should I read Receivables Turnover and DSO?
Receivables Turnover asks how quickly credit sales become collections. If Company A has credit sales of Rs. 120 and average receivables of Rs. 20, turnover is 6.0x and DSO is about 61 days. Company B has the same sales but receivables of Rs. 40, so turnover is 3.0x and DSO is about 122 days. A is collecting faster, which is usually better. But very low DSO may also mean the company is refusing useful credit sales.
How should I read Payable Days?
Payable Days shows how long the company takes to pay suppliers. If purchases are Rs. 120 and average payables are Rs. 20, payable days are about 61 days. If payables are Rs. 40, payable days are about 122 days. Higher payable days improve cash flow because suppliers are funding the business longer. But too high is risky if it means overdue suppliers, supply disruption, or poor bargaining power.
How should I read Asset Turnover?
Asset Turnover asks how much sales the company generates per rupee of assets. If Company A makes sales of Rs. 300 with assets of Rs. 150, turnover is 2.0x. Company B makes the same sales with assets of Rs. 300, turnover is 1.0x. A uses assets more efficiently. Higher is usually better, but some industries naturally need more assets, so compare with peers and margins.
How should I read Cash Conversion Cycle?
The Cash Conversion Cycle combines inventory days, collection days, and supplier credit. If inventory days are 90, DSO is 60, and payable days are 45, cash is locked for 105 days. If another company has the same inventory and DSO but payable days of 90, its cycle is 60 days. Lower is usually better because cash returns faster, but only if supplier relationships remain healthy.
Formula Lab
Understand the Formula
Read the formula like a business sentence before calculating it.
Formula 1
Inventory Turnover = COGS / Average Inventory
Formula 2
Inventory Days = 365 / Inventory Turnover
Formula 3
Receivables Turnover = Credit Sales / Average Receivables
Formula 4
DSO = 365 / Receivables Turnover
Formula 5
Payable Days = Average Payables / Purchases x 365
Formula 6
CCC = Inventory Days + DSO - Payable Days
Solved Case Study
Read the Numbers Like an Analyst
Work through one business case slowly: understand the situation, calculate the ratios, then interpret what the numbers are really saying.
Case context
A Jaipur manufacturer has COGS Rs. 1,200L, average inventory Rs. 300L, credit sales Rs. 1,800L, average receivables Rs. 360L, purchases Rs. 1,000L, and average payables Rs. 200L. Inventory turnover is 4.0x, inventory days are 91 days, receivables turnover is 5.0x, DSO is 73 days, payable days are 73 days, and CCC is 91 days.
Case: Same sales, different cash lock-up
Company A and Company B both have sales of Rs. 100L and COGS of Rs. 80L. A holds average inventory of Rs. 20L and receivables of Rs. 15L. B holds average inventory of Rs. 40L and receivables of Rs. 30L. Both have purchases of Rs. 75L; A has payables of Rs. 10L and B has payables of Rs. 25L.
Read inventory efficiency
Inventory Turnover and Inventory Days show whether stock is moving quickly or sitting in the business.
A is better on inventory because it produces the same business with half the stock blocked.
Read collection speed
Receivables Turnover and DSO show how quickly sales become cash.
A collects faster. B is giving customers much longer credit or struggling to collect.
Combine into the cash cycle
Payable days reduce the cash lock-up because suppliers fund part of the cycle.
A is still better. B gets more supplier credit, but not enough to offset slow inventory and slow collections.
Interpretation
What This Means In Practice
Read the result as a business signal, not as a standalone number.
Efficiency must still protect operations
Efficiency ratios ask how quickly business activity moves through the operating cycle. Inventory days show how long stock sits. DSO shows how long customers take to pay. Payable days show how much supplier credit supports operations. The cash conversion cycle puts all three together and tells us how long cash is locked before returning. Faster turnover or fewer days is useful only when it does not damage customer service, supplier relationships, production continuity, or sales growth.
What the number is really asking
Efficiency is not speed for its own sake. The real question is whether inventory, customer credit, supplier credit, and assets are being used to grow sales without trapping avoidable cash. The business question is how much revenue or cash is produced for every rupee tied up in inventory, receivables, payables, working capital, or assets.
Key Takeaway
Efficiency is not speed for its own sake. The real question is whether inventory, customer credit, supplier credit, and assets are being used to grow sales without trapping avoidable cash.
Practice Checkpoint
Check Your Understanding
Work through the quiz in smaller sets. Your answers stay visible while this page is open, so you can review before moving on.
Question 1 of 25
Level 1What does Inventory Turnover measure?
Question 2 of 25
Level 1What does DSO measure?
Question 3 of 25
Level 1Why is Payable Days not always better when higher?
Question 4 of 25
Level 1What does the Cash Conversion Cycle combine?
Question 5 of 25
Level 2COGS is Rs. 1,200L and average inventory is Rs. 300L. What is Inventory Turnover?
20 questions remaining in this lesson.
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