What is Your Operational Efficiency Ratio, and How to Improve It
There are a lot of indicators that tell consumers and professionals how well a business is doing. Those metrics often serve the businesses themselves but also investors looking to find the best place to grow their wealth.
One important piece of the equation is a business’s operational efficiency ratio. The operational efficiency of a company takes a number of essential things into account, and the combination of those things produces this important ratio.
We’re going to take a look at the idea of operational efficiency today, giving you some insight into what it means and how businesses can optimize it. Let’s get started.
What is An Operational Efficiency Ratio?
The operational efficiency ratio takes all of the expenditures of a business and runs them against sales. It’s also referred to as the “expense-to-sales” ratio. It seems like a simple idea, but it’s actually very complex even for small businesses.
Another way of looking at the fundamentals of the equation is in terms of profit. A company’s profit is the money that’s left over after all expenses are paid. Understanding profit, though, is a lot simpler than understanding the operational efficiency ratio.
The ratio gets broken down into a number of smaller aspects. Depending on the type of business, there could be any number of things that factor into the equation.
All Processes Get Taken into Account
Everything from the management of files to the way things are faced on the supermarket shelf could factor into operational efficiency. Most businesses include dozens, if not hundreds of different steps along the way to the sale being made.
All of those things require someone or something to perform a particular job in a particular way. If the operation gets managed well, all of those steps are performed in the most reasonable way time and time again. In most cases, that means that they are done in the way that is cheapest.
That said, there are other factors to prioritize as well, such as employee satisfaction, management of goods, and quality. So, there’s a balance of different actions that factor into the operational efficiency ratio.
In terms of financial outcomes, though, there are a few other individual ratios that work together to produce the operational efficiency ratio to present to investors, boards, and other individuals who have a vested interest in the financial success of a company.
Inventory Turnover Ratio
The inventory turnover is essentially the profit a company receives from inventory alone. It doesn’t take any of the other factors into consideration and looks at the pure ratio of cost to expense on your product set.
Another way of looking at inventory turnover ratio is as the rate at which a company sells out of its goods over particular periods of time. Divide the cost of goods sold and divide it by the average inventory in your stores at any time, and you get the inventory turnover ratio.
Accounts Receivable/Payable Turnover
The accounts receivable ratio indicates how efficient a company is at collecting its pay as well as how much pay that company collects. The ratio requires you to take the net credit sales and divide it by the average accounts receivable for a period of time.
“Net credit sales” refers to the money earned and collected at a later date. In other words, it’s money that a company is owed. Some might refer to this data set as “sales returns,” or “sales allowances.”
Considering that sales on credit require a number of additional factors to collect money, there are a lot of areas where things can slip through the cracks. This is especially true in large-scale businesses, so the accounts receivable ratio is an important aspect of operational efficiency.
The accounts payable turnover ratio refers to how well a company pays off the entities to which it’s in debt. To figure out this ratio, divide the net credit purchases by the average accounts payable.
“Net credit purchases” refers to the cost of goods sold plus the ending inventory balance, minus starting the inventory balance for that period. Average accounts payable is the starting and ending payable balance per month, per year.
How to Improve Operational Efficiency
The first thing to do is start gathering data on each aspect of your operation. The best way to improve your efficiency is to look at the numbers and see where you could make up some ground.
Once you’ve spotted the issue, you can take a look at how improvements would work in real life. That said, it’s too difficult to sniff out every operational imbalance without having a way to manage and organize that information.
If you’re running a small business, it might be possible to assess operational efficiency in real time. That said, you still need data to optimize things perfectly. Plus, without a clear account of the data, you can’t calculate the actual operational efficiency ratio that investors and others want to see.
One of the biggest liabilities in the operational efficiency equation is inventory. If your inventory or the handling of your inventory isn’t excellent, you’ll lose a lot of money.
That said, inventory management issues are some of the most difficult to fix. This is especially true in e-commerce logistics where you don’t always have eyes on most aspects of the process.
In the case of small businesses management, a lot of the issues occur in the shipping and storing of products. It’s difficult to know how much to order, how long it can sit on the shelves, and whether those products will all sell before your next shipment comes in.
The best way to improve things is with a little help. Read more here for professional help and insights on how to optimize your operation.
Want to Learn More About Small Business Management?
Dissecting a business’s operational efficiency ratio is one of the best ways to see how it’s doing. That ratio is also a good indication of how the business will perform in the future.
We’re here to help you to get a deeper understanding. Explore our site for more ideas on business management, inventory management, and a whole lot more.