Activity Ratios

Activity ratios, also known as productivity, efficiency, or turnover ratios, measure how effectively a company uses its assets to generate revenue. These ratios provide insights into the management of assets and help identify areas for improvement in operational efficiency. They demonstrate the relationship between sales and various assets.

1) Stock Turnover Ratio

Definition: This ratio measures how efficiently a company turns its inventory into sales within a specific period. It is also known as the Inventory Turnover Ratio or Stock Velocity Ratio.

Formula:

$\frac{COGS}{A v e r a g e S t o c k}$

Where:

COGS (Cost of Goods Sold) =

Sales – Gross Profit

Average Stock =

\frac{O p e n i n g S t o c k + C l o s i n g S t o c k}{2}

Significance:

Indicates the number of times inventory is sold and replaced over a period.
Helps in inventory management by identifying when to reorder stock.
A higher ratio suggests efficient inventory management, while a lower ratio indicates potential overstocking or slow-moving inventory.

2) Debtors Turnover Ratio

Definition: This ratio evaluates how efficiently a company collects revenue from its credit sales. It is also called the Accounts Receivable Turnover Ratio.

Formula:

$\frac{A v e r a g e D e b t o r s}{C r e d i t S a l e s}$

Where:

Average Debtors =

\frac{D e b t o r s + B i l l s R e c e i v a b l e}{2}

Average Collection Period:

$\frac{N u m b e r o f d a y s / w e e k s / m o n t h s }{D e b t o r s T u r n o v e r R a t i o}$

Significance:

Measures the effectiveness of the credit policy and the efficiency of collecting receivables.
A higher ratio indicates quick collection of receivables, while a lower ratio suggests issues with credit policies or collection processes.

3) Creditors Turnover Ratio

Definition: This ratio assesses how quickly a company pays off its suppliers. It is also known as the Accounts Payable Turnover Ratio.

Formula:

$\frac{N u m b e r o f d a y s / w e e k s / m o n t h s }{A v e r a g e C r e d i t o r s}$

Where:

Average Creditors =

\frac{O p e n i n g C r e d i t o r s + C l o s i n g C r e d i t o r s}{2}

Average Payment Period:

$\frac{N u m b e r o f d a y s / w e e k s / m o n t h s}{C r e d i t o r s T u r n o v e r R a t i o}$

Significance:

Indicates how efficiently a company manages its payables.
A higher ratio suggests quick payment to suppliers, while a lower ratio may indicate delayed payments, potentially affecting supplier relationships.

4) Working Capital Turnover Ratio

Definition: This ratio measures how efficiently a company uses its working capital to support its sales volume.

Formula:

$\frac{T o t a l S a l e s}{W o r k i n g C a p i t a l}$

Where:

Working Capital = Current Assets – Current Liabilities

Significance:

A high ratio indicates efficient utilization of working capital, though it could also signal excessive creditors.
A low ratio might suggest inefficiencies such as too many debtors or large inventory levels, which are not optimal use of resources.

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Activity Ratios