Stock turnover

· Stock turnover shows how many times, on average, a business sells and replaces its inventory/stock in a period.
· Formula: Stock turnover = Cost of sales ÷ Average stock.
· Average stock = $(Opening\ stock + Closing\ stock) \div 2$.
· High stock turnover usually means fast sales, efficient stock management, lower storage costs, and less risk of obsolete stock.
· Very high stock turnover can also signal understocking, risking stockouts and lost sales.
· Low stock turnover suggests slow-moving stock, overstocking, weak demand, or poor purchasing decisions.
· Interpretation depends on industry: a supermarket should usually have a higher stock turnover than a luxury furniture retailer.

This image shows how inventory turnover is calculated using cost of goods sold and average inventory. It helps students see exactly how the ratio is built from financial statement data. It is useful for linking the ratio to exam-style calculations and interpretation. Source

How to improve stock turnover

· Reduce excess inventory and improve stock control.
· Use better sales forecasting and more accurate demand planning.
· Increase sales through promotion, improved distribution, or stronger product-market fit.
· Remove or discount slow-moving stock.
· Improve inventory management systems such as tighter reordering and monitoring.
· Be careful: pushing stock turnover too high may cause stock shortages and customer dissatisfaction.

Debtor days

· Debtor days measure the average number of days customers take to pay what they owe to the business.
· Formula: Debtor days = Trade receivables (debtors) ÷ Revenue × 365.
· Lower debtor days are usually better because the business receives cash faster and improves cash flow.
· Higher debtor days can signal weak credit control, customers paying late, or overly generous credit terms.
· If a firm gives customers 30 days’ credit but debtor days are 55, that suggests late payment and possible cash flow pressure.
· Some industries naturally have higher debtor days, especially where trade credit is common.

This image shows the logic behind debtor days by first calculating accounts receivable turnover and then converting it into days. It helps students understand that fewer debtor days usually means faster collection and stronger short-term cash flow. It is especially useful for interpreting whether credit control is effective. Source

How to improve debtor days

· Tighten credit control procedures.
· Check customer creditworthiness before offering credit.
· Shorten the credit period offered to customers.
· Offer incentives for early payment, such as cash discounts.
· Chase overdue debts faster with reminders, statements, and follow-up.
· Consider factoring or stricter payment terms if cash flow is under pressure.
· Be careful: overly strict collection policies may damage customer relationships and reduce sales.

Creditor days

· Creditor days measure the average number of days the business takes to pay its suppliers.
· Formula: Creditor days = Trade payables (creditors) ÷ Cost of sales × 365.
· Higher creditor days can improve cash flow because the business keeps cash for longer.
· Lower creditor days may mean the firm is paying quickly, but it also means cash leaves the business sooner.
· A useful sign is often creditor days > debtor days because the business collects cash from customers before paying suppliers.
· However, very high creditor days may damage supplier relationships, reduce trust, or cause suppliers to stop offering trade credit.
· Interpretation must consider supplier expectations and the normal industry credit period.

This chart shows how debtor days and creditor days fit into the wider cash conversion cycle. It helps students understand why businesses aim to collect cash quickly while delaying payments to suppliers sensibly. It is excellent for evaluation because it connects ratios to real cash-flow timing. Source

How to improve creditor days

· Negotiate longer trade credit terms with suppliers.
· Build stronger supplier relationships so suppliers trust the business.
· Improve cash flow planning so payments can be scheduled strategically.
· Use the full agreed credit period without paying late.
· Centralize purchasing and payment systems to avoid inefficient early payments.
· Be careful: stretching creditor days too far can harm reputation, lose supplier goodwill, or lead to refusal of future credit.

Gearing ratio

· Gearing ratio measures the proportion of a business’s capital employed that is financed by long-term debt.
· Formula: Gearing ratio = Non-current liabilities ÷ Capital employed × 100.
· Capital employed = Non-current liabilities + Equity.
· High gearing means a greater reliance on loan finance and therefore higher financial risk.
· A highly geared business may face larger interest payments, lower flexibility, and greater danger if profits or cash flow fall.
· Low gearing means less dependence on debt and lower financial risk, but it may also mean the business is not fully using cheaper borrowed finance to grow.
· In evaluation, gearing should be judged against the firm’s industry, stability of cash flow, interest rates, and growth strategy.

This formula image explains a leverage measure closely related to gearing, showing how debt is compared with owners’ funds. It is useful for understanding why a business with more debt becomes financially riskier. For IB students, it supports interpretation of capital structure and long-term financial risk. Source

How to improve gearing ratio

· Reduce long-term debt by repaying loans.
· Increase retained profit.
· Issue more share capital.
· Sell unused assets and use the cash to reduce borrowing.
· Improve profitability so the business relies less on external long-term finance.
· Be careful: lowering gearing too aggressively may reduce opportunities for growth if debt finance could have been used productively.

Interpreting ratios together

· Stock turnover, debtor days, and creditor days are linked to working capital management.
· Best pattern for many businesses: high stock turnover, low debtor days, and reasonably high creditor days.
· This suggests stock is sold quickly, customers pay quickly, and suppliers are paid later — improving cash flow.
· Gearing is different: it focuses on capital structure and financial risk, not day-to-day working capital.
· A profitable business can still face problems if it has poor efficiency ratios or excessive gearing.
· Always comment on the likely business context: retailer, manufacturer, service business, seasonal business, or credit-based seller.

Insolvency versus bankruptcy

· Insolvency means a business cannot meet its debts when they fall due, or its liabilities exceed its assets.
· Bankruptcy is the legal status/process that can follow insolvency.
· A business can be insolvent before it is formally declared bankrupt.
· In exam answers, state clearly: insolvency is a financial condition; bankruptcy is a legal outcome or legal process.
· High gearing, slow debt collection, and poor cash flow management can increase the risk of insolvency.
· This is why efficiency ratios matter: they can provide early warning signs of financial distress.

This diagram shows the relationship between debt and equity in a business’s capital structure. It is useful for explaining why higher gearing increases financial risk and why debt holders are repaid before equity holders in financial distress. That link helps students connect gearing with the risk of insolvency and eventual bankruptcy. Source

Exam technique and common traps

· Use the correct figures from the correct statements: revenue from the income statement, trade receivables/payables from the statement of financial position, and cost of sales where required.
· For stock turnover, remember to use average stock, not just closing stock.
· Do not say a ratio is simply “good” or “bad” without context.
· Always compare ratios with previous years, industry averages, or the firm’s credit terms.
· When evaluating strategies, include at least one possible downside.
· Watch terminology: debtors = receivables and creditors = payables.