Activity Ratios in detail

Activity Ratios or Assets Management Ratio depicts how a company utilizes its assets to generate revenue. . It is used to check the level of investment made on an asset and the revenue that it is generating.

These ratios are the indicators of the operating performance of a business entity i.e, its capacity to convert assets into sales.

They are also known as turnover ratios or operating efficiency ratios.

 

TYPES OF ACTIVITY RATIOS

Commonly used Activity Ratios by various businesses are as follows:

 

  1. Inventory Turnover Ratio :- This ratio shows the relationship between the inventory or stock in the business and cost of the goods sold. It is calculated by dividing the cost of goods sold by the average inventory for the same period.

 

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

 

A low ratio indicates overstocking or poor management of inventory while a high ratio indicates good inventory management.

 

  1. Trade Receivable Turnover Ratio :- This ratio indicates the pace at which the company or a business entity is able to realize payments from its debtors.

 

Its formula is –

Trade Receivable Turnover Ratio = Credit Sales / Average Debtors

 

A higher ratio indicates that the credit policy of the company is sound, while a lower ratio shows a weak credit policy.

 

  1. Creditors Turnover Ratio :- This ratio measures the number of times a business entity pays to all its creditors in a given accounting period.

 

Creditors Turnover ratio = Net Credit Purchases / Average Creditors

 

  1. Working Capital Turnover Ratio :- This ratio indicates the efficiency with which business entity is able to generate sales or revenue with the amount of working capital available with it.

Working Capital Turnover =  Revenue from Operations/Capital Employed

 

A high ratio indicates proper utilization of the working capital whereas a low ratio indicates that the inventory is not being used properly.

 

  1. Investment Turnover Ratio or Net Asset Turnover Ratio :- This ratio indicates the overall ability of the business entity to generate revenues with the given amount of assets.

It is calculated as –

  Total Assets Turnover = Revenue/Average Total Assets

 

  1. Fixed Assets Turnover Ratio :- This ratio measures the business’ ability to generate sales from fixed assets such as property, plant and equipment.

Fixed Asset Turnover Ratio = Net Sales / (Fixed Assets – Accumulated Depreciation)

A high ratio indicates efficient utilization of fixed assets of the company to generate sales.

 

Thus, in simple words Activity ratios are very important indicators of the operating efficiency of the business & are used to measure a company’s ability to convert its assets, liabilities and capital accounts into cash or sales.

Accounting & Finance for Banking

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