We have discussed the importance of inventory control and careful monitoring of Accounts Receivable. There are two ratios commonly used to help you monitor these two critical assets: Inventory Turnover (Inventory Utilization) Ratio and Average Collection Period Ratio.

You can quickly test your inventory turnover using a ratio that is called Inventory Turnover Ratio or Inventory Utilization Ratio. This ratio looks at how quickly your inventory is being sold and restocked. The formula for this ratio is:

For Lisa’s Candle Shop, the Inventory Turnover Ratio is:

This means that Lisa will turn over her inventory 17.16 times per year. The industry average for miscellaneous retail stores is 6.55. Lisa’s Candle Shop is definitely turning over its inventory more rapidly than is common for these types of stores. Don’t you wish your business were doing this well? That’s an advantage of a make-believe world.

The ratio to test how well your company is doing at collecting its Accounts Receivable is called the Average Collection Period Ratio (ACP). The formula for this ratio is:

In calculating the month-end sales figures for Lisa’s Candle Shop, we assumed the same level for sales daily. Total store credit sales per day were $350 according to those assumptions.

For Lisa’s Candle Shop, the ACP ratio is:

You may remember that we noticed Lisa’s Candle Shop has some slow payers and this ratio shows that as well. It is taking the shop more than one month to collect money due. While it’s not terrible, it is slow. A good industry average is considered to be 36 days.

Now let’s take a look at a debt ratio that can greatly impact your ability to borrow money for your business.