Efficiency indicator – measuring the performance of a company
Efficiency is nothing more than the economy of resource use, and efficiency indicators help to monitor this.
Basic concepts for calculating efficiency indicators
Value of revenues realized during the main activity of the enterprise.
Property, plant and equipment that directly or indirectly serve the business in the short term.
Total receivables arising from the sale.
A claim is a payment claim legally arising from a contract that has already been settled by the contractor and accepted by the other party.
Total recognized liabilities arising from service contracts.
Property, plant and equipment (Tangible assets)
Tangible assets are items of property, plant and equipment is the totality of things that exist in the material form that are the property of the enterprise.
It is basically true for them that it is the quotient of some return and the resource needed to achieve it.
The yield can be
- sales revenue
- profit after tax
- anything that is the result of the company’s activities and its measurement is key to the business.
A company basically uses the following resources in its production:
- assets (tangible assets, fixed assets, current assets)
- capital (equity and debt)
Efficiency indicators are suitable for showing the financing cycle of a company, so we can monitor the development of the stock of customers and suppliers, as well as their relative proportions. Based on this, its efficiency can be measured from many directions, so it can be easily collected from the efficiency indicator with a small basket. A commonly used measure of efficiency analysis is the various rotational indexes as well as the ratios projected on some basis.
Depending on what goes into the denominator and the numerator, we can talk about straight and inverse efficiency indicators.
Straight efficiency indicator = return / resource used
It shows how much resources had to be used for a given amount of return (Actually, how much it cost the company to produce that particular return in money, work, or whatever). For these indicators, a value above 1 is acceptable. At this point, the resources used as a whole produce the return that the firm has set as an expectation for them.
Reverse efficiency indicator = resource used / return
It shows the return potential of a given amount of resources.
Efficiency indicators for assets
Asset efficiency = Net production value / Average asset stock
Tangible asset efficiency
Tangible asset efficiency = Net production value / Average tangible assets
Inventory efficiency = Material-free production value / Average inventory
Of course, you can further break down the categories according to your own business profile.
As the assets are typically used and replaced or produced by a company, here we count on an average stock.
The acceptable level of these indicators varies from industry to industry, although it is useful to have more than 1. In a production company, where the raw material is procured from outside, a part of the turnover is also quickly disbursed as a COGS, so that the company cannot take an asset from it. However, we cannot talk about this in a service company that uses little equipment.
Labor efficiency indicators
Wage efficiency = Material-free (Net) production value / (Wage cost + Other payments of a personnel expenses)
When you achieve the same production value with a lower labor cost, or a higher production value with the same labor cost, the wage efficiency indicator increases.
As the above efficiency indicator does not include all the money paid for employees, it is advisable to calculate the indicator with personnel expenses as well.
Net production value / Personnel expenses
Although you have no control over the contributions you pay, you have to pay, so it matters to you how efficiently you can manage your workforce.
Productivity = Net production value / Average number of employees
Per capita production value shows performance of proportional of headcount, thus providing an opportunity for comparability within an industry.
If you do not want to use production value as a basis, you can count on net sales revenue, COGS, if you only sell to one company (eg parent company), then it is advisable to use production value here.
Earnings level = (Wage cost + Other personal payments) / Average number of employees
Although it is not the typical efficiency indicator that would be directly related to production, it is still advisable to monitor its development. There are several reasons for this:
- staff expansion: if you know the average cost of 1 employee, it is easier to calculate with an expansion plan
- knowledge of cost structure: if you know what the money is going to, it is easier to set up an efficient pricing model
- monitoring competitors: when there is too much discrepancy between the level of earnings you offer and the level of earnings of competitors in your environment, it either impairs your efficiency (you pay more than others) or requires a wage settlement before your employees leave.
Complex efficiency indicator
Complex efficiency indicator = Net production value / (0.15 * Asset value + 1.8 * Wage cost)
The complex efficiency indicator allows you to examine the performance of the business by assessing the efficiency of the asset and live work together.
The multipliers of 0.15 and 1.8 in the denominator represent a minimum return expectation. If it’s more appropriate to work with a different return expectation in your own industry, feel free to do it. The acceptable level of this indicator is above 1.
Efficiency indicators for rotational speed
It practically shows the “pace”, the time until 1 full cycle is completed. This also affects the efficiency of the business. Rotational speed is not usually interpreted independently. Either compared to the previous period or to other players in the industry.
Basically, we monitor the following:
- inventory turnover rate: shows how fast the business can sell its inventories
- customer term: the average number of days your customers pay
- supplier term: on average, how many days you pay your suppliers
The business cycle of a business is current assets make 1 turn. That is, the stocks become a trade receivable and then become a sales revenue. In the meantime, of course, suppliers need to be funded.
Stock turnover rate
This should show the turnover of both purchased inventories (materials, goods) and self-produced inventories.
Inventory Speed = Cost of Sales / Average Inventory
Here we are counting on costs related to sales, not sales revenue. This is because the profit margin is also included in the sales revenue, and this can distort the indicator.
Inventory turnover time (in days) = 365 / Stock rotation speed
If I want to write this in a formula, I can do it like this:
Inventory turnover time (days) = (Average inventory * 365 days) / Cost of sales
Inventory management in businesses has a significant impact on efficiency. Capital invested in dead stocks, their storage costs, impairs profitability as much as stocks that are only available late.
The turnover rate of inventories indicates the time period in which the company sells its existing inventories. The high value also draws attention to two things:
- the enterprise has its resources committed for that much longer
- it also records stocks that are either non-marketable or fixed assets
Turnover time of suppliers = (Average supplier stock * 365 days) / Gross material expenditure
It shows the average number of days a business pays its suppliers. For this length of time, suppliers finance the operation of the business, but too high a value can also indicate liquidity problems or a large degree of insolvency.
Trade payables are usually related to the purchase of materials or goods, which also has a VAT content. Thus, this indicator is compared to material expenses, and the gross value is required due to the VAT content.
Turnover time of customers = (Average customer base * 365 days) / Gross sales revenue
It shows the average number of days customers pay. On the one hand, the high value imposes a financing burden on the company, and on the other hand, it also means a possible overdue or uncollectible trade receivable.
Since the customer stock will be a sales revenue, which may also have a VAT content, here we are already comparing the turnover rate to the gross sales revenue. Of course, you can also net your trade receivables and count on net sales revenue.
Until money is received from customers, suppliers need to be funded, and this requires some working capital. This period is the funding cycle. The longer this period, the greater the burden on the business.
- Which indicator do you use to monitor the operation of your company?
- What do you usually focus on for each indicator?
- How do you address the potential challenges of the funding cycle?
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