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What are Activity Ratios?

Activity ratios are financial metrics used to gauge how efficient a
company’s operations are. The term can include several ratios that can
apply to how efficiently a company is employing its capital or assets
Activity ratios are useful for comparing how a company’s performance is

trending over time in a horizontal statement analysis or how a company’s
performance fares against its peers in comparable company analysis.
They are also known as turnover ratios or operating efficiency ratios.
Categories of Activity Ratios
Activity ratios are classified into three main categories:
1. Working Capital
Working capital, also referred to as operating capital, is the excess

of current assets over current liabilities. The level of working capital
provides an insight into a company’s ability to meet current liabilities as
they come due. Achieving a positive working capital is essential; however,
working capital should not be too large in order not to tie up capital that
can be used elsewhere.
There are three main components of working capital are:
1. Receivables
2. Inventory
3. Payables
The three accounts are useful in determining the cash conversion cycle, an

important metric that measures the time in days in which a company can
convert its inventory into cash.
Receivables
The accounts receivable turnover measures how efficiently a company is

able to manage its credit sales and convert its account receivables into
cash.
Receivables Turnover = Net Credit Sales / Average Receivables
The accounts receivables turnover ratio depicts how good a business

is at giving credit to its customers and collecting debts. Calculating
the accounts receivables turnover ratio only considers the credit
sales are considered and not cash sales. A higher ratio indicates the
being paid by the customers on time, which helps to maintain
the cash flow and payment of the business’s debts, employee salaries,
etc. It is a good sign when the accounts receivables turnover ratio is
higher since the debts are paid on time instead of written off. It shows
a healthy business.
A high receivables turnover signals that a company is able to convert its

receivables into cash very quickly, whereas a low receivables turnover
signals that a company is not able to convert its receivables as fast as it
should.
Example:
Roots Inc. is a supplier of heavy machinery spare parts. All its

customers are major manufacturers, and all transactions carry on a
credit basis. The net credit sale for Roots Inc. for the year ended was
$1 million and the average receivables for the year were $250,000.
One can calculate the accounts receivables turnover ratio as below: –
= $1,000,000 / $250,000
Account Receivables Turnover Ratio = 4
Roots Inc. can collect its average receivables four times a year. In other
words, the average receivables recover every quarter.
The Days of Sales Outstanding (DSO) measures the number of days it

takes to convert credit sales into cash.
Days of Sales Outstanding = Number of Days in Period / Receivables

Turnover
360/4= 90 days
Inventory
Inventory turnover measures how efficiently a company is able to manage

its inventory.
Inventory Turnover = Cost of Goods Sold / Average Inventory
This activity ratio formula shows how often the inventory has been
sold completely in one accounting period for a business that holds
inventory.
Inventory Turnover Ratio = Cost of Goods Sold / Average Cost of

Inventory
A low inventory turnover ratio is a sign that inventory is moving too slowly
and is tying up capital. On the other hand, a company with a high
inventory turnover ratio can be moving inventory at a rapid pace;
however, if the inventory turnover is too high, it can lead to shortages and
lost sales.
Example:
The cost of goods sold for Binge Inc. is $10,000, and the average
inventory cost is $5,000. Therefore, one can calculate the inventory
turnover ratio as below: –
= $10,000 / $5,000
Inventory Turnover Ratio = 2

The inventory has been sold out twice in a fiscal year. In other words,
it takes six months for Binge Inc. to sell its entire inventory. Too much
cash in inventories is not good for a business. Hence, one must take
necessary measures to increase the inventory turnover ratio.
Days of Inventory on Hand (Inventory Conversion Period)= Number

of Days in Period / Inventory Turnover
360/2=180 days
Payables
Payables turnover measures how quickly a company is paying off its

accounts payable to creditors.
Payables Turnover = Credit Sales / Average Payables
A low payables turnover can indicate either lenient credit terms or an

inability of a company to pay its creditors. A high payables turnover can
indicate that a company is paying creditors too fast or it is able to take
advantage of early payment discounts.
Example:
The cost of goods sold for Binge Inc. is $10,000 on Credit, and
the average Payables cost is $5,000. Therefore, one can calculate the
Payables turnover ratio as below: –
= $10,000 / $5,000
Payables Turnover Ratio = 2

Binge Inc. can pay its average Payables 2 times a year. In other words,
the average Payment to be made is every 6 months.
Days of Payables Outstanding (DPO) measures the number of days it

takes to pay off creditors.
Days of Payables Outstanding = Number of Days in Period / Payables

Turnover
360/2=180 days.
Cash Conversion Cycle
As noted earlier, the cash conversion cycle is an important metric in

determining how efficiently a company can convert its inventories into
cash. Companies want to minimize their cash conversion cycle so that
they receive cash from sales of inventory as quickly as possible. The
metric indicates the overall efficiency of a company’s working
capital/operating assets’ utilization.
3. Total Assets
The total assets turnover ratio calculates the net sales compared to its

total assets. In other words, it depicts a business’s ability to generate
revenue. It helps investors understand the efficiency of companies in
generating revenue using their assets.
Total assets refer to all the assets that are reported on a company’s
balance sheet, both operating and non-operating (current and long-term).
Total asset turnover is a measure of how efficiently a company is using its
total assets.
Total Assets Turnover = Revenue / Average Total Assets
A high ratio indicates that a company is using its total assets very
efficiently or that it does not own many assets, to begin with. A low ratio
indicates that too much capital is tied up in assets and that assets are not
being used efficiently in generating revenue.
Example:
PQR Inc. generated revenue of $8 billion at the fiscal year-end. The

total assets at the start of the year were $1 billion and, at the end of
the year, $2 billion.
Average Total Assets = ($1 billion + $2 billion) / 2
= $1.5 billion
Total Assets Turnover Ratio is calculated as below:
= $8,000,000,000 / $1,500,000,000
Total Assets Turnover Ratio = 5.33

A higher total asset turnover ratio depicts the efficient performance of
the business.
Fixed Assets Turnover Ratio

The fixed assets turnover ratio measures the efficiency of a business in
utilizing its fixed assets. It shows how the company uses fixed assets to
generate revenue. Unlike the total assets turnover ratio, which focuses
on the total assets, the fixed assets turnover ratio focuses only on the
business’s fixed assets. Therefore, when the fixed assets turnover ratio
declines, it results from over-investment in any fixed assets like a
plant or equipment, to name a few.
Fixed Assets Turnover Ratio = Sales / Average Fixed Assets.
Example:
Net sales of Sync Inc. for the fiscal year were $73,500. At the beginning
of the year, the net fixed assets were $22,500. Moreover, after
depreciation and new assets addition to the business, the fixed assets
cost $24,000 at the year-end.
Average Fixed Assets = ($22,500 + $24,000) / 2
Average Fixed Assets= $23,250.
One must calculate the fixed assets turnover ratio as below: –

= $73,500 / $23,250
Fixed Assets Turnover Ratio = 3.16

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What are Activity Ratios?

Activity ratios are useful for comparing how a company’s performance is

Categories of Activity Ratios

Activity ratios are classified into three main categories:

Working capital, also referred to as operating capital, is the excess

There are three main components of working capital are:

The three accounts are useful in determining the cash conversion cycle, an

The accounts receivable turnover measures how efficiently a company is

Receivables Turnover = Net Credit Sales / Average Receivables

The accounts receivables turnover ratio depicts how good a business

A high receivables turnover signals that a company is able to convert its

Roots Inc. is a supplier of heavy machinery spare parts. All its

One can calculate the accounts receivables turnover ratio as below: –

Account Receivables Turnover Ratio = 4

The Days of Sales Outstanding (DSO) measures the number of days it

Days of Sales Outstanding = Number of Days in Period / Receivables

Inventory turnover measures how efficiently a company is able to manage

Inventory Turnover = Cost of Goods Sold / Average Inventory

Inventory Turnover Ratio = Cost of Goods Sold / Average Cost of

Inventory Turnover Ratio = 2

Days of Inventory on Hand (Inventory Conversion Period)= Number

Payables turnover measures how quickly a company is paying off its

Payables Turnover = Credit Sales / Average Payables

A low payables turnover can indicate either lenient credit terms or an

Payables Turnover Ratio = 2

Days of Payables Outstanding (DPO) measures the number of days it

Days of Payables Outstanding = Number of Days in Period / Payables

Cash Conversion Cycle

As noted earlier, the cash conversion cycle is an important metric in

The total assets turnover ratio calculates the net sales compared to its

Total Assets Turnover = Revenue / Average Total Assets

PQR Inc. generated revenue of $8 billion at the fiscal year-end. The

Total Assets Turnover Ratio is calculated as below:

Total Assets Turnover Ratio = 5.33

Fixed Assets Turnover Ratio

Fixed Assets Turnover Ratio = Sales / Average Fixed Assets.

Average Fixed Assets = ($22,500 + $24,000) / 2

Average Fixed Assets= $23,250.

One must calculate the fixed assets turnover ratio as below: –

Fixed Assets Turnover Ratio = 3.16

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