Accounting – 1.1 The purpose of accounting | e-Consult

Accounting information is a powerful tool for monitoring a business's efficiency and effectiveness – how well it uses its resources to achieve its goals. It allows management to identify areas where improvements can be made. Here are three examples:

• Inventory Turnover Ratio (Income Statement & Balance Sheet): This ratio (Cost of Goods Sold / Average Inventory) measures how efficiently a business manages its inventory. A high turnover ratio indicates that inventory is selling quickly, which is generally a sign of good efficiency. A low turnover ratio might suggest that inventory is sitting in storage for too long, tying up capital and potentially becoming obsolete. Management can use this information to improve inventory management practices, such as reducing overstocking or implementing more effective sales promotions.
• Accounts Receivable Turnover Ratio (Income Statement & Balance Sheet): This ratio (Credit Sales / Average Accounts Receivable) measures how quickly a business collects payments from its customers. A high turnover ratio indicates that the business is efficient in collecting receivables. A low turnover ratio might suggest that the business has lenient credit terms or is experiencing difficulties in collecting payments. Management can address this by tightening credit terms, improving invoicing processes, or implementing more effective collection methods.
• Cost of Goods Sold (Income Statement & Balance Sheet): Analyzing the cost of goods sold helps assess the efficiency of the production process. A rising cost of goods sold relative to sales could indicate inefficiencies in production, procurement, or manufacturing. Management can investigate the reasons for the increase and take corrective action, such as negotiating better prices with suppliers, improving production processes, or reducing waste. Comparing the cost of goods sold to industry benchmarks can also provide valuable insights.
• Operating Ratio (Income Statement): This ratio (Operating Expenses / Operating Revenue) measures the efficiency of the business's core operations. A lower operating ratio indicates greater efficiency. Management can use this information to identify areas where operating expenses can be reduced, such as streamlining processes or negotiating better deals with suppliers.

By regularly monitoring these and other efficiency and effectiveness indicators, businesses can identify areas for improvement and optimize their operations. This leads to increased profitability and a stronger competitive position.