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How well does a business manage its assets and how exposed is it to debt?

Calculate and interpret efficiency and financial stability ratios to evaluate asset management and gearing

Efficiency ratios such as inventory turnover and debtors collection measure how well assets are used; financial stability ratios such as the debt ratio and equity ratio measure long-term solvency and exposure to debt.

Generated by Claude Opus 4.76 min answerUpdated 2026-05-29

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this dot point is asking
Efficiency ratios
Financial stability ratios
Reading them together

What this dot point is asking

You need to calculate the standard efficiency and stability ratios, state their formulae, and interpret what they reveal about how a business is run and funded.

Efficiency ratios

Efficiency (activity) ratios measure how productively assets are managed.

A higher inventory turnover means stock sells quickly, freeing cash and reducing the risk of obsolescence. A shorter debtors collection period means customers pay faster, improving cash flow.

Financial stability ratios

Financial stability (solvency) ratios measure the ability to meet long-term obligations and the reliance on borrowed funds.

A high debt ratio means the business is heavily geared, which raises returns when trading is good but increases risk if profits fall, because interest must still be paid. The debt ratio and equity ratio together add to 100 percent of total assets.

Calculating and reading the ratios

Figures for the year

Cost of goods sold \ $360,000; average inventory \$ 60,000; average debtors \ $40,000; net credit sales \$ 500,000; total assets \ $800,000; total liabilities \$ 320,000; owner's equity $480,000.

Inventory turnover $= \dfrac{360{,}000}{60{,}000} = 6$ times a year (stock turns over roughly every two months).

Debtors collection period $= \dfrac{40{,}000}{500{,}000} \times 365 = 29.2$ days, so customers pay in about a month.

Debt ratio $= \dfrac{320{,}000}{800{,}000} \times 100 = 40\%$ .

Equity ratio $= \dfrac{480{,}000}{800{,}000} \times 100 = 60\%$ .

Interpretation: stock and debtors are managed well, and at 40 percent debt the business is moderately geared with the owner funding the majority. The two funding ratios sum to 100 percent, confirming the calculation.

Reading them together

Efficiency and stability ratios complete the picture started by profitability and liquidity. Fast inventory turnover and quick debtor collection support liquidity. A low debt ratio reduces risk but may mean the owner is not using borrowing to grow. As always, a ratio is judged against trend and industry context, not a single benchmark.

Gearing creates a trade-off the owner must weigh. Borrowing magnifies the return on owner's equity when the business earns more on the borrowed funds than the interest costs, but it magnifies losses just as sharply when trading turns down, because interest is a fixed commitment. A retailer with rapid inventory turnover can carry more debt safely than one holding slow-moving stock, since its assets convert to cash quickly. This is why the efficiency ratios and the stability ratios are read together: the speed at which assets become cash partly determines how much debt the business can prudently support.

Exam-style practice questions

Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

2024 SACE Stage 24 marksCalculate the following forecast ratios for Kyandi's Kreations as at 30 June 2025: the debt ratio, the debt to equity ratio, and the working capital ratio. (Total assets

188,000, total liabilities

108,000, net equity

80,000, current assets

68,000, current liabilities $18,000.)

Show worked answer →

Use the SACE formulas, showing working for each.

Debt ratio = total liabilities / total assets = 108,000 / 188,000 = 57.4%. More than half the assets are financed by debt.
Debt to equity = total liabilities / owner's equity = 108,000 / 80,000 = 135%. The business owes $1.35 for every$ 1 of equity, so it is fairly highly geared.
Working capital (current ratio) = current assets / current liabilities = 68,000 / 18,000 = 3.78 : 1. There are $3.78 of current assets for every$ 1 of current liabilities, indicating strong short-term liquidity.

Markers reward the correct formula, correct figures and the right unit for each (percentage, percentage, and a ratio). State the debt ratio and debt to equity as percentages and the working capital ratio as a ratio.

2023 SACE Stage 22 marksIdentify a solvency ratio that a bank would use to determine whether a business is eligible for a loan, and calculate this ratio for Lakeland Sports for 2023. (Total liabilities

391,200; total assets

648,000; equity $256,800; profit plus interest available.)

Show worked answer →

A bank assessing long-term solvency would use the debt ratio (or debt to equity, or times interest earned).

Debt ratio = total liabilities / total assets = 391,200 / 648,000 = 60.4%.

This means about 60% of the assets are funded by debt. A bank reads a high debt ratio as higher risk, because the business is heavily reliant on borrowed funds and has less of an asset buffer if it cannot repay. The result here would make a bank cautious about extending further finance.

Markers reward naming a genuine solvency (long-term stability) ratio, the correct formula and figures, an answer as a percentage, and a brief interpretation linked to lending risk.

2021 SACE Stage 22 marksCalculate the 2021 debt ratio for Enduring Couture, then explain how this ratio could be used by an internal stakeholder.

Show worked answer →

Debt ratio = total liabilities / total assets, expressed as a percentage. Substitute the business's totals and show the working to reach the percentage.

Use by an internal stakeholder: the owner (an internal user) uses the debt ratio to judge how reliant the business is on borrowed funds and whether it is over-geared. A rising debt ratio warns the owner that interest commitments and repayment risk are growing, which may influence decisions to repay debt, slow expansion, or inject more capital rather than borrow further.

Markers reward the correct formula and percentage, plus an explanation that names the owner as the internal user and links the ratio to a real management decision about gearing or financing.