Efficiency Ratios: Inventory turnover, collection (DSO), and payment (DPO)
Efficiency Ratios: Inventory turnover, collection (DSO), and payment (DPO)
Profit is not enough; speed matters. Activity Ratios (Efficiency Ratios) measure how fast a company converts its resources into cash. By analyzing the Cash Conversion Cycle (CCC), you can understand the time gap between paying suppliers and collecting from customers. This guide provides the practical path for mastering operational efficiency metrics—Digital Salla.
- Inventory Turnover (DIO): How long does stock sit on shelves?
- Receivables Turnover (DSO): How fast do customers pay?
- Payables Turnover (DPO): How long do you take to pay suppliers?
- Cash Conversion Cycle (CCC): The net days cash is tied up.
- Interactive Tool: CCC Calculator to optimize working capital.
1) What are Activity Ratios? (Speed of Business)
These ratios measure how efficiently a company manages its Working Capital components (Inventory, AR, AP). While profitability ratios tell you “how much” you made, activity ratios tell you “how fast” you made it.
2) Inventory Turnover & Days Inventory Outstanding (DIO)
Measures how many times inventory is sold and replaced over a period.
- Formula: COGS / Average Inventory
- DIO Formula: 365 / Inventory Turnover
- Goal: Lower DIO is generally better (means faster sales), provided no stockouts occur.
3) Receivables Turnover & Days Sales Outstanding (DSO)
Measures the efficiency of credit policy and collection efforts.
- Formula: Net Credit Sales / Average Accounts Receivable
- DSO Formula: 365 / Receivables Turnover
- Goal: Lower DSO means faster cash collection.
4) Payables Turnover & Days Payable Outstanding (DPO)
Measures how long the company takes to pay its suppliers.
13-Week Cash Forecast - Excel Template
- Formula: COGS / Average Accounts Payable
- DPO Formula: 365 / Payables Turnover
- Goal: Higher DPO is better for cash flow (using suppliers’ money), but must not damage relationships.
5) Cash Conversion Cycle (CCC) (SVG Diagram)
The Cash Conversion Cycle calculates the net number of days cash is tied up in operations.
Formula: DIO + DSO – DPO
6) Total Asset Turnover
Measures the ability of total assets to generate sales.
Formula: Net Sales / Average Total Assets.
A high ratio indicates efficient asset utilization (doing more with less).
7) Interactive Tool: CCC Calculator
Enter your figures to calculate your operational timeline.
8) Frequently Asked Questions
Can CCC be negative?
Yes. If DPO is very large (you pay suppliers late) and you collect cash quickly (low DSO) and sell fast (low DIO), you get cash before you pay for goods. This is excellent for liquidity (e.g., Supermarkets).
What is the difference between Inventory Turnover and DIO?
They measure the same thing but in different units. Turnover is “times per year”, DIO is “number of days”. 365 / Turnover = DIO.
Does high Asset Turnover mean high profit?
Not necessarily. It means high sales volume relative to assets. If margins are low, profit could still be low despite high turnover (e.g., Discount Retailers).
9) Conclusion
Activity Ratios are the speedometer of your business. Monitoring DIO, DSO, and DPO helps you identify bottlenecks in your operational cycle. Reducing your Cash Conversion Cycle is the cheapest way to generate cash without borrowing—Digital Salla.