Different Types of Activity Ratios You Should Know About

Activity ratios measure how effectively a business uses its resources to generate income. They provide insight into how efficiently a company can convert its assets and capital into cash or sales. Different types of activity ratios can help assess the effectiveness of a business’s operations.

These ratios are also called asset management ratios or performance/ efficiency ratios. Here, our trusted accountant in Framingham shares all about the types of activity ratios:

What Are the Different Types of Activity Ratios?

Several different types of activity ratios measure various aspects of a company’s performance:

Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio is one such ratio that is used to measure how quickly a business collects its receivables. It is calculated by dividing the total amount of a company’s sales over a given period by its average accounts receivable. 

A high accounts receivable turnover ratio indicates that a business can collect its receivables quickly, while a low ratio indicates the opposite. A high accounts receivable turnover ratio is desirable, showing that a company collects its money promptly and efficiently. 

Working Capital Ratio

The working capital ratio is calculated by dividing a company’s current assets by its current liabilities. A higher ratio means that there are more current assets than current liabilities, and the company is more likely to be able to meet its short-term obligations. A lower ratio indicates that the company may have difficulty paying its short-term debts.

The working capital ratio is an important ratio for lenders and investors, as it indicates the company’s ability to cover its short-term liabilities. 

A company with a high ratio may be able to generate more cash from its current assets than its competitors. On the other hand, a low ratio may indicate that the company is not using its existing assets efficiently and is at risk of running out of cash.

Asset Turnover Ratio

The asset turnover ratio is an important measure of a company’s performance. It measures the efficiency with which a company uses its assets to generate sales. It is calculated by dividing the company’s total sales by its total assets. A higher asset turnover ratio indicates that the company is more efficient in utilizing its assets to generate sales.

The asset turnover ratio can be used to compare the efficiency of different companies in using their assets to generate sales. It can also be used to identify companies that are more efficient in using their assets than others. 

Fixed Asset Turnover Ratio

The Fixed Asset Turnover Ratio is a measure of how efficiently a company is using its fixed assets to generate sales. It is an important measure of a company’s performance and is used to assess its ability to generate sales from its fixed assets. 

The higher the fixed asset turnover ratio, the more efficiently the company is using its fixed assets to generate sales. A high fixed asset turnover ratio indicates that the company can generate more sales from its fixed assets than a company with a lower ratio. 

Inventory Turnover Radio

The inventory turnover ratio is an essential tool for measuring a company’s performance, because it shows how efficient the company is at converting its inventory into sales. A low ratio indicates that the company cannot quickly convert its inventory into sales, which could mean that it is not managing its inventory efficiently. On the other hand, a high ratio indicates that the company is managing its inventory efficiently and is able to convert its inventory into sales fast.

Days Payable Outstanding

DPO is a useful metric for investors and creditors to evaluate a company’s financial health and liquidity. It is an important indicator of how well a company is managing its working capital and cash flows. A high DPO means that the company is taking longer to pay its suppliers, which can lead to increased costs and a decrease in supplier relations. On the other hand, a low DPO indicates that the company is paying its suppliers quickly, which can lead to better supplier relations and lower costs.

Conclusion

Activity ratios provide insight into a company’s performance over a certain period. They are often used to compare a company’s performance with its competitors or past performance. By analyzing these activity ratios, with the help of a top CPA, companies can better understand their financial performance and help them make informed decisions that will benefit the company in the long term.

Ash CPA can provide you with the services of a trusted accountant in Framingham, MA, that can help you monitor and improve the performance of your business. Get in touch with us today to learn about our services!