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Types of Activity Ratios with Examples

Activity Ratios or Assets Management Ratio depicts how a company utilizes its assets to generate revenue. In simple words, the activity ratio denotes the ratio between the invested amount in the particular asset type and the revenue generated by such asset. This is the reason why activity ratio is also known as efficiency ratio, turnover ratio or productivity ratio.

 

 

Stock Turnover Ratio

Stock turnover ratio is the most important activity ratio as it helps in understanding the relationship between inventory/average stock and the cost of goods sold. Stock turnover ratio is also known as inventory turnover ratio or stock velocity ratio as it indicates the speed of stock conversion into sales or revenue.

Formula:

Stock Turnover Ratio = COGS / Average Inventory

Where,

COGS = Sales – Gross Profit, &

Average Inventory = (Opening Stock + Closing Stock) / 2

Higher Stock Turnover ratio shows that a business is generating sufficient revenue and goods purchased are converting into sales rapidly. This helps the management to schedule inventory reordering. On the other hand, lower Stock Turnover ratio depicts the slow conversion rate of the stock into revenue.

Example

Calculate inventory turnover ratio of XYZ Ltd. As per the given Information:

Opening inventories

50,000

Closing inventories

60,000

Cost of goods manufactured   

4,90,000

 

Solution:

Cost of goods sold = 50,000 + 4,90,000 – 60,000 = 4,80,000

Average inventories = (50,000 + 60,000) / 2 = 55,000

Inventory turnover ratio = 4,80,000 ÷ 55,000 = 8.73

 

Debtor Turnover ratio

Debtor Turnover ratio indicates how a business deals with their Bills Receivables due to which it is also known as Account Receivable Turnover ratio. Through Debtor Turnover ratio a business can determine the relationship between the credit sales and average debtors.

Formula:

Debtor Turnover ratio = Credit Sales / Average Debtors or

Debtor Turnover ratio = Credit Sales / Debtors + Bills Receivables

Where,

Average Debtor = (Opening Debtor + Closing Debtor) / 2

Higher Debtor Turnover ratio represents that credit policies created by the management of a business is efficient and need no alteration. Whereas the lower ratio shows that management needs to work on their credit policies or have to change the existing credit policy of the business.

Example

Let us assume XYZ has the following result of the previous financial year:

Opening Debtors

64,000

Closing Debtors

72,000

Credit Sale      

8,00,000

 

Solution:

Average Debtors = (64,000 + 72,000) / 2 = 68,000

Debtor Turnover ratio = 800,000 / 68,000 = 11.76

Creditors Turnover Ratio

Creditors Turnover ratio represents how a business deals with their Bills Payables that is why it is also known as Accounts Payable Turnover ratio. Through Creditor Turnover ratio a business can determine the relationship between the credit purchase and average creditors.

Formula:

Creditors Turnover Ratio = Credit Purchase / Average Creditors OR

Creditors Turnover Ratio = Credit Purchase / Average Creditors + Bills Payable

Where,

Average Creditor = (Opening Creditor + Closing Creditor) / 2

Higher Creditor Turnover ratio represents the efficiency of credit purchases policies created by the management of a business. Whereas the lower ratio shows that management needs to alter the existing credit purchase policy of the business.

Example

Let us assume XYZ has the following result of the previous financial year:

Opening Creditors

30,000

Closing Creditors

50,000

Credit Purchase           

5,00,000

 

Solution:

Average Creditors = (30,000 + 50,000) / 2 = 40,000

Creditors Turnover ratio = 5,00,000 / 40,000 = 12.5

Working Capital Turnover Ratio

Working Capital Turnover Ratio is another important turnover ratio that helps the business to determine the utilization efficiency of the working capital of a business. This ratio explains the relationship between Sales / COGS and working capital.

Formula

Working Capital Turnover Ratio = Sales or Cost of Goods Sold / Working Capital

Where

COGS = Sales- Gross Profit, &

Working Capital = Current Assets – Current Liabilities

Generally, higher Working Capital Turnover ratio means that a business working capital is efficiently utilized. On the contrary, the lower ratio shows that a business is having too many debtors or there is a lot of inventory lying that is not an efficient use of resources.

Example

Calculate Working Capital Turnover ratio of XYZ Ltd. As per the given Information:

Net Sales

5,00,000

Current Asset

10,00,000

Closing Creditors

7,50,000

Solution:

Working Capital = 10,00,000 – 7,50,000 = 2,50,000

Working Capital Turnover Ratio = 5,00,000 / 2,50,000 = 2