Activity ratios can be utilized to measure the effectiveness of an organization in utilizing its assets to generate money and revenues. They are used to determine the amount of investment made on an asset as well as the amount of revenue it generates. This is why the activity ratio is called the efficiency ratio, or the more well-known turnover ratio.

The purpose of the turnover ratio or activity ratio is to evaluate the effectiveness of a company through careful analysis of inventory, fixed assets and receivables.

Let’s look at the various kinds of activity ratios.

Types of Activity Ratios

1. The ratio of stock turnover or inventory Turnover Ratio
2. The ratio of debtors to turnover or the Turnover Ratio of Accounts Receivable
3. The ratio of the creditor’s turnover or the Turnover Ratio for Accounts Payable
4. Working Capital turnover rate.
5. Investment Turnover Ratio

The following topics are covered below.

Stock Turnover Ratio

It is among the most significant turnover ratios that highlights the relationship between the stock or inventory within the company and the cost of the products sold. It reveals how quickly the inventory is cleared within the accounting period, or in another words, the amount of times the stock is used or sold. It is the reason it is also referred to as the rate of turnover in inventory.

It is calculated using the formula below

Stock Turnover Ratio = Cost of Goods Sold / Average Inventory

A high ratio of stock turnover is a sign of rapid-moving products in a business, while an extremely low ratio suggests that the products are not being sold or are kept in warehouses for a prolonged time.

Debtor Turnover Ratio

This is an important measure of a business that indicates how a business can offer additional the credit facility to its clients and can also recover the amount due during the time frame of payment.

It’s also referred to as the accounts receivable turnover ratio since the payment for credit sales to come in the near future are referred to as accounts receivables.

The formula to calculate Ratio of Debtors Turnover is

Debtor Turnover Ratio = Credit Sales / Average Debtors

A higher ratio means an organization’s credit policies are sound. business is solid, whereas the ratio that is lower indicates an insufficient credit policy.

Creditors Turnover Ratio

The turnover rate of creditor’s is an indicator of the ability of a company to repay the purchase of credit effectively in an accounting time.

It reveals the number of times account payables are cleared by the business in an accounting time. It is the reason it is also referred to as the turnover of accounts payable ratio.

The formula to calculate creditors turnover ratios is

The ratio of creditor turnover is net credit purchases / average of creditors

In addition, average creditors are called the average account payable.

A high ratio means that the business can finance all purchases of credit, and the reverse is also true.

Working Capital Turnover Ratio

This is a useful ratio for determining the efficiency with which the company can make use of its working capital in creating sales of its products.

The formula to calculate working capital turnover ratios is

The ratio of working capital turnover = Cost of Sale or Goods Sold/Working Capital

If a business has a higher amount of working capital, it indicates how the capital employed by the company is properly utilized and on the other hand, a lack of working capital may indicate that the company has enough debtors and that the inventory is not being used.

Investment Turnover Ratio or Net Asset Turnover Ratio

The Investment Turnover Ratio is a function of to the amount of sales that are taking place within the business as well as the net assets or capital employed. It defines the ability of a business to earn revenue from sales through the utilization of net assets owned by the business. The ratio is determined together the formula below.

Investment Turnover Ratio = Net Sales/ Capital Employed

Importance of Activity Ratios

Activity ratios are vital indicators of the efficiency of the company. They also show the manner that revenues are generated by an organization and the manner that the components in the financial statement are utilized to manage the business.

The article was about Activity Ratios. The concepts discussed in this article can provide a great help to students to develop a solid understanding of the Turnover or Activity Ratios. For more articles like this be sure to check out Eduacademy.