Commonly Used Terms

How quickly a business can turn its assets into cash or sale is a good indicator of how well that business is being run. Activity Ratio measures how effectively a business uses its assets. It is commonly referred to as efficiency ratios; activity ratios are a fine indicator of how a company handles its inventory management. 

Management and accounting departments use multiple Activity Ratios to gauge the efficiency of their businesses. These Activity Ratios are as follows:

1. Total Assets Turnover Ratio
2. Fixed Assets Turnover Ratio
3. Inventory Turnover Ratio
4. Accounts Receivable Turnover Ratio
5. Working Capital Ratio 

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How to calculate activity ratio?

1. Total Assets Turnover Ratio : This ratio measures how fast a company turns its assets into revenue. It measures the efficiency with which a business uses its assets to generate sales. 

Total Assets Turnover Ratio = Sales / Average Total Assets

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

Fixed Assets Turnover Ratio = Net Sales/ (Total Fixed Assets - Depreciation)

3. Inventory Turnover Ratio: Reveals the number of times a company created its inventory and sold it over a certain period of time. It denotes the efficiency with which the inventory is managed. 

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Inventory Turnover Ratio = Costs of Goods Sold/ Average cost of Inventory.

4. Accounts Receivable Turnover Ratio : It depicts how efficiently a business provides credit to its customers and collects debts. To measure this ratio, only the credit sales are taken into account and not the cash sales. 

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Accounts Receivable Turnover Ratio = Net Credit Sales/ Average Accounts Receivable

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It is a good sign when the accounts receivables turnover ratio is high since the debts are being paid on time.

5. Working Capital Ratio : Working capital is current assets less current liabilities. The ratio helps the business figure out the net annual sales generated by the average amount of working capital for a year.

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Working Capital Ratio = Net sales/ Average Working Capital.