How Do You Define an Activity Ratio?
One form of financial indicator is the activity ratio, which measures how well a firm turns its balance sheet assets into revenue and cash flow. Activity ratios, also known as efficiency ratios, provide insight into a company’s inventory management, a vital factor in its operational smoothness and financial health, for investors and analysts.
Calculating Effectiveness Ratios
The best application of activity ratios is to compare two similar firms operating in the same industry to see how one firm compares against the competition. Yet another use of activity ratios is monitoring a company’s financial performance over time. These figures may be plotted to show how a business will likely fare.
The following are some of the sub-types that may be found among activity ratios:
Turnover Ratio of Accounts Receivable
The accounts receivable turnover ratio measures the capacity to collect money from consumers. Sales made on credit are shown as a percentage of the period’s average AR balance. The data collection may have been a problem if the ratio is low.
Productive Use of Stored Goods
The turnover ratio for goods inventories is a statistical indicator of the frequency with which inventory is sold throughout a certain accounting period. The average inventory for a certain period is divided by the cost of items sold. If the numbers add up, it should be easy for the corporation to trade its stock.
Rate of Return on Total Assets
The total asset turnover ratio quantifies how well a company markets its wares. The efficiency with which a company utilizes its assets may be calculated by dividing its total revenues by its total assets. A lower percentage might indicate that the firm is having trouble moving inventory.
Earnings Per Share
Return on equity (ROE) is a performance indicator used to analyze a company’s profitability relative to the equity invested by its shareholders. Return on equity is determined by dividing net income by the total marketable stock shares.
Ratio of Assets Turnover
The asset turnover ratio calculates the company’s earnings per dollar invested in its assets. The ratio between sales and total assets indicates a company’s ability to turn its resources into revenue.
Profitability vs. Activity Ratios Ratios
Basic analytical techniques that aid investors in assessing various aspects of a company’s financial health include activity and profitability ratios. Efficiency ratios assess how well a business uses its resources to create profits, whereas profitability ratios illustrate how profitable the business is. Analysts may use profitability ratios to compare a company’s earnings to those of its rivals in the same industry and monitor the company’s performance over time.
Conclusion
- Financial analysts and investors may use activity ratios to measure a company’s ability to turn its assets into revenue and cash flow.
- Businesses in the same industry may be compared using activity ratios, and the same ratios can be used to track a company’s financial health over time.
- Various activity ratios exist, such as assessing the frequency with which assets are turned over or the rate at which equity is returned.
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