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IB Syllabus 3.6
IB Syllabus 3.6
The learning outcomes (or assessment objectives) for this section of the IB Business Management syllabus are:
The following efficiency ratios (AO2, AO4):
Stock turnover
Debtor days
Creditor days
Gearing ratio
Possible strategies to improve these ratios (AO3)
Insolvency versus bankruptcy (AO2)
In-Class Activities
In-Class Activities
Day 1: Strategies to Improve Efficiency Ratios
Day 1: Strategies to Improve Efficiency Ratios
Complete this table for evaluating strategies to improve efficiency ratios:
https://docs.google.com/document/d/1EofiJL4C9SroA6bBtYZn_7vt2ub7Z6eaqC3yQVfIcLM/edit?usp=sharing
Day 2: Case Study Options
Day 2: Case Study Options
Option 1: Research a company
Research a company and find their:
Efficiency Ratios (Stock turnover, Debtor days, Creditor days, Gearing ratio)
If you use Yahoo Finance you can find the Income Statement and Balance Sheet on the "Financial" Tab
Note that Debtors is also called Receivables and Creditors is called Payables or Account Payables
Liquidity ratios (Current Ratio, Acid Test Ratio)
Based on the ratios would you invest into the company? Why or why not?
If you were a bank would you lend them money? Why or why now?
Option 2: Case Study Practice Questions
15. Fresh Cucina (FC)
17. Spielgeist Games
Homework
Homework
Read Kognity +
Option 1: IBDB Google Slides
Complete all practice questions in the slides as well
Option 2: 3.5-3.6 Case Study Questions:
15. Fresh Cucina (FC)
17. Spielgeist Games
Complete all practice questions except for the 10 mark questions
Additional Homework: 3.5 Liquidity Practice Exam Questions
What you should know
By the end of this subtopic, you should be able to:
define the following terms: (AO1)
efficiency ratio
stock turnover ratio
debtor days
creditor days
gearing ratio
insolvency
bankruptcy
explain and calculate efficiency ratios: stock turnover, debtor days, creditor days and gearing ratio (AO2, AO4)
evaluate possible strategies to improve efficiency ratios (AO3)
distinguish between insolvency and bankruptcy (AO2)
https://quizlet.com/_d0kwy2?x=1jqt&i=4jrhob
https://www.gimkit.com/view/641f83d5cab4d50032877516
3.5-.3.6 https://www.gimkit.com/view/67ea08d30250ac6bdae9b0dd
Creditor days ratio
(how quickly a business pays its own debts)
The efficiency ratio that measures the average number of days an organization takes to repay its creditors (suppliers who the business has bought products from using trade credit, so have yet to pay for these).
Debtor days ratio
(how quickly a business is able to collect its debts)
The efficiency ratio that measures the average number of days an organization takes to collect debts from its customers (as they have bought goods and services on trade credit but have yet to pay for these).
Efficiency ratio
Financial planning and decision-making tool to measure how well the resources of a business are used in order to generate income from the firm’s capital.
Gearing ratio
(the proportion of a business’s capital that has been raised through potentially costly/risky long-term debt)
The efficiency ratio that measures the extent to which an organization is financed by external sources of finance (i.e. loan capital as a percentage of the firm’s total capital employed).
Stock turnover ratio
(how quickly a business is able to sell its stocks)
The efficiency ratio that measures the number of days it takes a business to sell its stock (inventory). The ratio can also show the number of times during any given period of time (usually a year) that the business restocks or replaces its inventory.
3.6 Extra Notes
3.6 Extra Notes
The following efficiency ratios (AO2, AO4):
The following efficiency ratios (AO2, AO4):
Stock turnover
Debtor days
Creditor days
Gearing ratio
- Stock turnover
The stock turnover ratio (also known as the inventory ratio) measures the number of times, on average, that a company sells and therefore replenishes its stock within a period of time, usually a year.
Measures how efficiency a company is managing its inventory levels.
Note: cost of sales from the income statement
A higher ratio indicates more efficient inventory management as stock is turning over more frequently into sales.
A declining ratio may signal overstocking, slow sales, or obsolete inventory issues.
Too high a ratio could lead to stock-outs and lost sales.
Not relevant for service businesses with negligible inventory levels.
Comparables (competition): Can compare to other companies in the same industry as ratios vary between industries.
Historical: can compare to previous performance as well within the company
Example:
The cost of sales for the Riz and Javi supermarket is $300 million per year and that its opening stock is $60 million and closing stock $40 million.
Calculate the stock turnover ratio:
This means that the Riz and Javi supermarket sold out of its stock six times per year, or every 60.83 days.
Compare to comparable supermarkets and own historical performance to see how well it compares.
- Debtor days
The debtor days ratio measures the average number of days it takes the business to collect its debts.
Typically, credit periods can be 30, 60 or 90 days.
The shorter the period, the better for the business.
Note: Debtors from the statement of financial position (balance sheet)
Note: Total Sales Revenue from the statement of profit or loss (income statement).
Note: Debtors also called Receivables
Businesses that sell goods on credit must collect payment from debtors (customers) at a later date, unlike cash sales
Important for businesses to collect debts promptly to avoid cash flow issues from delayed inflows
A high or increasing debtor days ratio signals potential cash flow problems if debts are not recovered quickly enough
Businesses must balance generous credit terms to attract customers with risks of delayed cash finflows straining liquidity
Poor credit control policies that don't enforce limits or timely payments can weaken a business's cash flow
Selling goods on credit is common for durable consumer goods with long lifespans like vehicles, machinery, refrigerators
If Debtor days are lower than Creditor days that's GREAT!
It means we collect money faster than we need to pay it out.
Businesses want to minimize debtor days and maximize creditor days.
Bargaining for debtors days too be too quick though may cause you to annoy your customers or even lose their business
Example
Riz and Javi supermarket, which also sells some durable consumer products, has a debtor value of $34 million and a total sales revenue of $500 million.
Calculate Riz and Javi's debtor days
This is probably a good debtor days figure for the supermarket.
A credit period longer than 30 days would impact a supermarket’s cash flow negatively, as it needs to restock regularly.
Generally, businesses should avoid high debtor days figures. However, if the debtor days are too low, the business could lose customers who need a bit longer to pay for the products. So a good balance needs to be found.
- Creditor days
The creditor days ratio is an indicator of the average number of days it takes a business to pay its debts.
Common for businesses to buy resources on credit, with a payment period of 30, 60 or 90 days, depending on the amount and the trust between the business and the supplier.
Note: creditors figure from the statement of financial position (balance sheet)
Note: cost of sales figure from the statement of profit or loss (income statement).
Note: Creditors also called Payables
The longer the creditor days, the better for the business.
A longer payment period means businesses don't have to spend cash in the working capital cycle as quickly
Reduces the pressure of the working capital cycle for the business.
A shorter period may reduce the cash available for the business in its operations.
If Creditor days are higher than Debtor days that's GREAT!
It means we collect money faster than we need to pay it out.
Businesses want to minimize debtor days and maximize creditor days.
Bargaining for creditor days too be too long though may cause you to annoy your suppliers
Example
Riz and Javi Supermarket has a creditors value of $45 million and its cost of sales, as in the earlier example, is $300 million.
Calculate Riz and Javi's creditor days ratio
55 days is probably an acceptable creditor days period for the supermarket.
It is not uncommon for suppliers to give credit terms of 30 to 60 days.
If Debtor days are 31 and Creditor days are 55 then the company will be okay if people pay a bit later
Financial Ratios - Receivables and Payables Days
Note: Receivables = Debtors ; Payables = Creditors
- Gearing ratio
The gearing ratio measures how much of the business’s capital employed is financed by long-term debt, such as non-current liabilities.
The higher the gearing ratio, the more of the business’s operations are funded by long-term debt.
This is risky and may not be positive for the business because, if interest rates increase, then loan payments could rise and undermine profits and dividends to shareholders.
Company may be considered "over leveraged" with too much long-term debt
More debt -> more risky the company is
There is a risk the company cannot pay their interest payments and become insolvent and then bankrupt with too much debt.
What's a good gearing ratio?
Below 25% is generally considered low
25% to 50% considered normal for many businesses, especially those that are well-established
Above 50% is considered high
Capital employed: non‐current liabilities + equity (balance sheet).
Note; Non‐current liabilities is on the balance sheet.
Fun fact: Why would companies borrow lots of money if it makes them higher risk?
It's because it means owners don't have to invest as much of their own money (equity) and thus their return on equity goes up (they make more money for every dollar they invest) when the company makes money
Example
Riz and Javi supermarket has non‐current liabilities of $240 million and a capital employed of $625 million (can find these in the balance sheet).
Calculate the gearing ratio for the Riz and Javi supermarket.
This means that 38.4% of the company’s operations are financed by long-term loans. This is within a normal range
25%-50% considered normal
However, the business may also want to find out what the average gearing ratio is in their industry to see how their business compares with other similar businesses.
Possible strategies to improve these ratios (AO3)
Possible strategies to improve these ratios (AO3)
Strategies to improve the stock turnover ratio
Strategies to improve the stock turnover ratio
Strategies to improve debtor days
Strategies to improve debtor days
Strategies to improve creditor days
Strategies to improve creditor days
Strategies to improve the gearing days
Strategies to improve the gearing days
Insolvency versus bankruptcy (AO2)
Insolvency versus bankruptcy (AO2)
Insolvency
Insolvency is a situation where an individual or a business is not able to pay its debts (liabilities exceed its assets).
Insolvency does not automatically lead to bankruptcy
You can be insolvent, but not bankrupt if you haven't started the legal process for bankruptcy
Can happen from:
Debtor days are too long. Customers take a long time to pay for products, which reduces the cash flow into the business.
Loss of sales revenue. This can occur due to internal factors, such as poor-quality products or high labour turnover, or external factors, such as increased competition or poor economic conditions.
Increased costs. This can occur due to internal factors, such as inefficient production and waste, or external factors, such as increased competition for resources, inflation or rising interest rates.
Legal action. If the business is sued, it may be forced to pay high legal fees or even settlements.
Bankruptcy
Bankruptcy is a legal process (declared by court) that may give an insolvent business a chance to restructure its operations and debt, so that it may become profitable again.
The legal state when a firm is unable to pay off debts, i.e., legal procedures after being declared insolvent
You are definitely insolvent if you are bankrupt
Provides immediate relieve to insolvent individuals or businesses
Don't have to pay debts right away
Creditors cannot refuse bankruptcy and are legally bound to the process
Bankruptcy can result in liquidating assets to pay creditors, though full repayment is unlikely
Liquidating assets is one of the last resorts for a business as that means you're selling the assets needed to run the company and make money
If the business is liquidated, it has sold all it's asses and will cease to exist
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