---
# System prepended metadata

title: Efficiency Ratios
tags: [dd]

---

---
breaks: false
tags: dd
title: Efficiency Ratios
description: Efficiency Ratios, also known as Activity Ratios, help investors evaluate the efficiency with which a business is able to use its assets to generate revenue.
---

## Efficiency Ratios

### Asset Turnover Ratios

One of the most basic operational aspects of a business is generating sales
using its assets. We can measure the efficiency of this operational aspect
using the **asset turnover ratio** which can be defined as

```
Asset Turnover Ratio = Total Income / Average Assets
```

We'll consider the average of the total assets during a financial year to
account for potentially abrupt changes in total assets due to unusual events
like sales of fixed assets, increase in goodwill etc.

Asset Turnover Ratio is one of the components in the DuPont Identity we used to
calculate the Return on Equity in the [Profitability
section](https://indiainvestments.gitbook.io/content/stocks/financial-metrics-and-ratios/profitability#return-on-equity-roe-and-return-on-assets-roa).

As we've mentioned before, it wouldn't make sense to compare ratios between
companies in different sectors. FMCG companies usually enjoy high asset
turnover while asset heavy companies and financial institutions don't.

![The Profit and Loss Statement of Hindustan Unilever for the financial year 2019](https://i.imgur.com/GB9aBxt.jpg)

> The Profit and Loss Statement of Hindustan Unilever for the financial year 2019

![Part 1 of the Balance Sheet of Hindustan Unilever for the financial year 2019](https://i.imgur.com/sJKEmTG.jpg)

> Part 1 of the Balance Sheet of Hindustan Unilever for the financial year 2019

The total income of Hindustan Unilever Ltd for the year 2019 is `₹39,860
crores` and the average total assets are `(₹18,629 + ₹17,862)/2 = ₹18,245.5
crores`. The asset turnover ratio of Hindustan Unilever for the year 2019 is
`₹39,860 / ₹18,245 = 2.18`. In contrast, the asset turnover ratio of Nestle
India for the year 2019 is `1.66`. If we observe the past 5 year trend, Hindustan
Unilever has had an asset turnover ratio of greater than 2 while Nestle India
has had an asset turnover ratio of greater than 1 but less than 2. Using this
information, we can infer that Hindustan Unilever is *possibly* more efficient
at generating revenue from its assets than Nestle India.

The asset turnover ratio of a company can get skewed due to a number of unusual
events such as asset sales, issue of additional shares, investment into assets
for long term growth, deliberately increasing inventory to meet demand etc.
It's best if we look at a trend of how asset turnover ratio has been in the
past 5 years before jumping to conclusions. Let's consider the financial
statements of Avenue Supermarts for the year 2020.

![Part 1 of the Balance Sheet of Avenue Supermarts for the year 2020](https://i.imgur.com/MF77K9t.png)

> Part 1 of the Balance Sheet of Avenue Supermarts for the year 2020

The asset turnover ratio of Avenue Supermarts for the year 2019 is `3.16`.
However, due to issue of additional shares and the investment of the capital
gained into non-current financial assets, the asset turnover ratio drops to
`2.61` in the financial year 2020.

Although we've seen what asset turnover ratio is, we can go ahead and refine it
further to get a more useful metric. Instead of considering total assets, we'll
now consider only the non-current, or fixed, assets of a company to calculate
the **Fixed Asset Turnover Ratio**. Why not consider the current assets? Well,
most companies and sectors where asset turnover ratios are relevant often
invest in long term assets to generate sales. We'll focus on current assets in
the working capital and cash conversion cycle.

We can define fixed asset turnover ratio as

```
Fixed Asset Turnover Ratio = Total Income / Average Non Current Assets
```

The fixed asset turnover ratio of Hindustan Unilever Ltd for the year 2019 is
`₹39,860 / ((₹6,715 + ₹6,202) / 2) = 6.17` while that of Nestle India for the
year 2019 is `3.82`.

### Inventory Turnover, Receivables Turnover, and Payables Turnover
### Inventory Days, Days Receivable, Days Payable (DSI, DSO, DPO)
### Cash Conversion Cycle
### Working Capital