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:
- Total Assets Turnover Ratio
- Fixed Assets Turnover Ratio
- Inventory Turnover Ratio
- Accounts Receivable Turnover Ratio
- Working Capital Ratio
How to calculate activity ratio?
- 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
- 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)
- 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.
Inventory Turnover Ratio = Costs of Goods Sold/ Average cost of Inventory.
- 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.
Accounts Receivable Turnover Ratio = Net Credit Sales/ Average Accounts Receivable
It is a good sign when the accounts receivables turnover ratio is high since the debts are being paid on time.
- 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.
Working Capital Ratio = Net sales/ Average Working Capital.