A financial measurement that gives insight into how well and efficiently a business uses its assets.
Activity Ratio Details
Activity ratio is a metric measurement to visualize just how efficiently a business can turn its assets into money. Accounting and management departments use several types of activity ratios to indicate the company's efficiency. There are many different types of activity ratios that a company can use for different purposes.
A common use for activity ratio is as a comparison with other businesses in similar fields or demographics. It is always useful for businesses to be aware of the numerical differences with their rival peers. A company can specifically aim the activity ratio at one branch of the system within and not just the overall business. For example, the analysis of how much investment is going into one particular group of assets or how much profit has new machinery produced.
A company that has just released a new piece of merchandise will almost always track its progress and efficiency with activity ratios. It's an indispensable tool that measures current performance and can predict future profits. A business should always be aware of what is generating what, and if anything is holding you back, how can you turn it around.
Activity Ratio Example
Let's use the Accounts Receivable Turnout ratio to measure its ability to turn its assets into cash. Our hypothetical company has $7,000,000 in Net Credit sales, and a total of $700,000 in Opening Receivables, and $300,000 in Closing Receivables. The company will first calculate its average Accounts Receivables. In this case, it's 500,000 ((700,000 + 300,000) / 2). The Net Credit sales become divided by the average and the result is the accounts receivable ratio of the company, which is 14.
Another company calculates using Fixed Assets Turnover ratio. The company wants to analyze just how much value is in their property. If there isn't much, then they will start to look into letting go of them one way or another. It starts off by uncovering the values of their sales, which is $3,000,000, and the average of their fixed assets. The Opening Fixed assets are $700,000 while the Closing Fixed assets stand at $500,000. The average of these two values ends up at 600,000. The sales divided by the fixed assets (3,000,000 / 600,000) is a ratio of 5.
Types of Activity Ratios
Here is a quick overview of six different types of Activity Ratios:
- Accounts Receivable Turnouts Ratio: Being the most essential and used activity ratio in the business, it evaluates how much the company can turn its accounts receivables into cash profit. Its basic formula is Net Credit Sales divided by the Average Accounts Receivable
- Working Capital Turnover Ratio: It measures just how much a company can profit utilizing its working capital to generate sales. Its formula is Sales of Goods Sold divided by the Working Capital
- Days Payable Outstanding Ratio: It is essentially a calculation of a deadline. It is used to grasp the number of days the company has to complete its payments. The formula used is Accounts Payable divided by the Cost of Sales divided by the Number of Days.
- Creditors Turnover Ratio: As its name suggests, it's a tool used to determine how well the business can pay off all credit purchases without falling into financial trouble in a certain time frame. It is measured by dividing the Net Credit Purchases with the Average Creditors.
- Fixed Assets Turnover Ratio: This activity ratio is used to estimate how much a company's fixed assets, for example, equipment, property, etc., can be used to generate sales. To calculate the ratio, you have to divide net sales by the total of fixed assets minus the accumulated depreciation.
- Net Asset Turnover Ratio: Also known as the investment turnover ratio, this activity ratio is quite simple. It's related to the generated sales by utilizing the net assets of the business. It's calculated by dividing the Net Sales by the Capital Employed.