Astute investors always opt for plans that are likely to yield high returns irrespective of market conditions. Efficiency level, which measures a company’s capability to transform available input into output, is often considered an important parameter used to gauge a company’s potential to rake in handsome returns.

A company with a favorable efficiency level is expected to provide stellar returns as it is believed to be positively correlated with price performance.

How to Measure Efficiency?

We have considered four popular ratios in order to find efficient companies that have the potential to provide impressive returns.

Inventory Turnover

The inventory level is one of the key indicators of a company’s business health. While a high inventory level may indicate that the company is going through a rough phase in terms of sales, a dwindling level may indicate that it will run out of stock in a favorable sales condition. This is where inventory turnover comes into play. It is the ratio of 12-month cost of goods sold (COGS) to a four-quarter average inventory. Thus, a high value of the ratio indicates a low level of inventory relative to COGS, while a low ratio signals that the company has excess inventory.

Receivables Turnover

This ratio is used to measure a company’s capability to extend its credit and collect debts on the basis of that credit. Receivables turnover ratio or the “accounts receivable turnover ratio” or the “debtor’s turnover ratio” is calculated by dividing 12-month sales by four-quarter average receivables. While a high ratio indicates that the company efficiently collects its accounts receivables or has quality customers, a low ratio signals that the company has an inefficient collection procedure or has low-quality customers or an inefficient credit policy.

Asset Utilization

This is a widely used measure of a company’s efficiency. Asset utilization indicates a company’s potential to utilize its assets. It is a ratio of total sales over the past 12 months to the last four-quarter average of total assets. So, the higher the ratio, the greater is the chance that the company is utilizing its assets efficiently. On the contrary, a low value of the ratio signals that it is failing to use its assets effectively.