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Efficiency Ratios

You are analyzing the company's ability to sell merchandise and collect receivables in a timely manner, calculating the following things:

1. inventory turnover ratio,
2. days’ sales in inventory ratio,
3. gross profit percentage,
4. accounts receivable turnover ratio, and
5. days’ sales in receivables ratio.

To calculate the efficiency ratios for Lucky 7, Inc., you will need the following information from the company’s income statement and balance sheet. You will be calculating the efficiency ratios for 2016.

Inventory Turnover

This ratio measures the number of times a company sells its average inventory over a given time period (usually a year). Inventory turnover is calculated as follows:

• inventory turnover (2016) = cost of goods sold (2016) / average inventory
• inventory turnover = $200,000 / (($59,000 + $42,000) / 2)
• inventory turnover = $200,000 / $50,500
• inventory turnover = 3.96 times

The average inventory for 2016 is the average of the inventory amounts on the 2015 and 2016 balance sheets. Inventory on December 31, 2015, was $42,000, and the inventory on December 31, 2016, was $59,000.

Days’ Sales in Inventory

This ratio measures the average number of days that a company holds inventory before it is sold. Days’ sales in inventory is calculated as follows:

• average days’ inventory on hand (2016) = days in year / inventory turnover
• average days’ inventory on hand = 365 / 3.96
• average days’ inventory on hand = approximately 92 days

Some textbooks use 360 days instead of 365 days. We ignore leap year when there are 366 days.

Gross Profit Percentage

The gross profit percentage measures gross profit as a percentage of sales (or net sales). This was calculated when you completed the vertical analysis of the income statement. Gross profit percentage is calculated as follows: NOTE: This formula does not appear in the textbook.

• gross profit percentage (2016) = gross profit / net sales revenue
• gross profit percentage = $320,000 / $520,000
• gross profit percentage = 61.54%

Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio measures the number of times that a company collects its average accounts receivable over a period of time (usually a year). Accounts receivable turnover ratio is calculated as follows:

• accounts receivable turnover (2016) = net credit sales (2016) / average accounts receivable
• accounts receivable turnover = $520,000 / (($17,500 + $19,500) / 2)
• accounts receivable turnover = $520,000 / $18,500
• accounts receivable turnover = 28.11 times

The average accounts receivable for 2016 is the average of the accounts receivable amounts on the 2015 and 2016 balance sheets. Accounts receivable on December 31, 2015, was $19,500, and accounts receivable on December 31, 2016, was $17,500.

Days’ Sales in Receivables

The days’ sales, on average, measures the average number of days it takes to collect accounts receivable. Days’ sales in receivables is calculated as follows:

• average days’ sales in inventory (2016) = days in year / inventory turnover
• average days’ sales in inventory = 365 / 28.11
• average days’ sales in inventory = approximately 13 days

Some textbooks use 360 days instead of 365 days. We ignore leap year when there are 366 days.