1. Rate of Stock Turnover
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Definition: This ratio shows how quickly a business sells its inventory over a specific
period, typically a year.
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Formula:
Rate of stock turnover =
Cost of sales
Average stock
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The answer is expressed as the number of times.
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Interpretation: A higher turnover rate indicates efficient inventory management and sales.
A low rate may suggest overstocking or slow-moving inventory.
2. Stock Holding Period (Inventory Holding Period)
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Definition: This indicator reflects the average number of days inventory is held before it is
sold.
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Formula:
Stock holding period = Average stock
Cost of sales
X
365_
1
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The answer is expressed as the number of days.
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Interpretation: A shorter holding period means that inventory is being converted into sales
quickly, which is typically desirable. A longer holding period could indicate issues with
selling the inventory.
3. Debtors' Collection Period
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Definition: This measures the average time it takes for a company to collect payments
from its debtors after a sale on credit.
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Formula:
Debtors’ collection period =
Average debtors
Credit sales
X
365_
1
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The answer is expressed as the number of days.
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Interpretation: A shorter collection period indicates that the business collects its debts
faster, improving liquidity. A longer period suggests that it takes more time to collect from
customers, which can impact cash flow.
4. Creditors' Payment Period
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Definition: This ratio shows the average time a business takes to pay its suppliers after
purchasing goods on credit.
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Formula:
Creditors’ payment period =
Average creditors__
Credit purchases
X
365_
1
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The answer is expressed as the number of days.
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Interpretation: A longer payment period allows the business to hold onto its cash longer,
but extending the period too much can strain relationships with suppliers.
Ideal relationship between the debtors’ collection period and the creditors’ collection period:
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DCP ≤ CPP: Ideally, the business should collect payments from its debtors before it has to
pay its creditors. This helps in maintaining sufficient liquidity and reduces the need for
external financing.
o
Longer Creditors' Payment Period (CPP): If the business can negotiate a longer
payment period with its creditors, it has more time to collect cash from its debtors
and avoid short-term cash shortages.
o
Shorter Debtors' Collection Period (DCP): By reducing the time it takes to collect
receivables, the business improves cash flow and can meet obligations to creditors
more easily.
o
For example, if a business has a debtors' collection period of 30 days and a
creditors' payment period of 60 days, it means that the business has 30 days of
positive cash flow, where it can use the money from debtors to settle creditor
obligations without needing external funding.
5. Debt-Equity Ratio
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Definition: This ratio measures the relative proportion of a company's debt to its
equity. It indicates the extent to which the business is financed by borrowed capital. It
also indicates the degree of financial risk of the business.
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Formula:
Debt : Equity ratio = Non-current liabilities : Owner’s equity
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The answer is expressed as the ratio of non-current liabilities : owner’s equity.
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Interpretation: A higher debt-equity ratio indicates that the company is more leveraged,
meaning it relies more on borrowed funds. A lower ratio suggests a stronger reliance on
equity, indicating lower financial risk.