Activity Ratios and their Interpretation

In this series so far, we have covered an overview of the accounting ratios, and we have also looked at Profitability Ratios. We will look through other ratios in future posts, leading up to exploring how we can visualise accounting data in business visualisation.

Screenshot (1)

Activity Ratios are also known as Efficiency Ratios. Essentially, they help to measure the effectiveness of a firm in utilising its assets. There are three main activity ratios:

Stock Turnover Turnover: this ratio answers the question: how effective is the organisation in using its assets to generate sales? It measures the effectiveness of the organisation in generating sales by looking at the margin and turnover. For example, it can show if an organization has an unusually low or high level of fixed assets.

Stockholding Period: This ratio answers the question: how long does the stock remain inside the boundaries of the firm?

Debtor Days (Debtor Collection Period): This ratio answers the question: how long is it until trade debtors pay?

Creditor Days (Creditor Payment Period): This ratio answers the question: how long is it until trade customers pay?

Calculating the Activity Ratios

Stock Turnover is expressed as a number:

Cost of Goods sold/

Average Stock

Stockholding Period is specified in days:

Stock Held /

Stock Used

Debtor Days is specified in days:

Trade Debtors /

Credit Sales

Creditor Days is specified in days:

Trade Creditors /

Credit Purchases

Interpretation of the Ratios

There is a relationship between Return on Net Assets, Net Profit and Net Asset Turnover.  It is useful to look at sales and compare it with the constituents of these ratios. So, if there is a small Net Asset turnover, we can find out if it is made up of fixed or current assets, and this can help us to identify which type of assets makes up the ratio.

Stock turnover can sometimes be used with Sales revenue, but this contains profit which can cause the figure to be misleading.

Summary

As in the case of the other ratios, we cannot just use one number. Next, we will look at Liquidity Ratios in order to understand better how the organization is managing with its working capital.

 

 

 

 

 

 

 

 

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