Define Activity Ratios

 Define Activity Ratios

What Is an Activity Ratio, and What Does It Mean?

An activity ratio is a sort of financial indicator that shows how effectively a firm is generating revenue and cash from its balance sheet assets. Activity ratios, also known as efficiency ratios, assist analysts assess how a firm manages inventories, which is critical to its operational flexibility and overall financial health.

TAKEAWAYS IMPORTANT

• An activity ratio is a financial indicator that investors and research analysts use to determine how well a firm uses its assets to create revenue and cash.

• Activity ratios can be used to compare two organisations in the same industry, or they can be used to track the financial health of a single company over time.

• Merchandise inventory turnover ratios, total assets turnover ratios, return on equity measures, and a variety of other indicators are all examples of activity ratios.

Activity Ratios: What You Need to Know

Activity ratios are especially effective when comparing two competitive firms within the same industry to see how one company compares to its competitors. Activity ratios, on the other hand, may be used to analyse a company's financial development throughout several accounting periods and spot changes over time. These figures can be mapped to provide a future-looking picture of a company's performance.

The following sub-categories can be found in activity ratios:

Turnover of Accounts Receivables

The capacity of a business to recover money from its clients is determined by the accounts receivable turnover ratio. For a given period, total credit sales are divided by the average accounts receivable amount. A low ratio indicates a problem with the collecting procedure.

Inventory Turnover Ratio for Merchandise

The merchandise inventory turnover ratio determines how frequently the inventory balance is sold over the course of a financial year. The average inventory for a given period is divided by the cost of items sold. Higher estimations indicate that a company's inventory can be moved with relative ease.

Turnover of Total Assets

The total assets turnover ratio determines how well a company utilises its assets to make a sale. Total revenues are divided by total assets to determine how well a company uses its resources. Smaller ratios might suggest that a corporation is having difficulty moving its goods.

Return on Investment (ROI)

Return on equity (ROE) is a performance indicator that quantifies the revenue generated from shareholder equity. The return on equity (ROE) is computed by dividing net income by the total number of outstanding stock shares in the market.

Ratio of Asset Turnover

The asset turnover ratio is a statistic that analyses how much income a firm makes per dollar of assets. This ratio, which can be easily computed by dividing a firm's revenues by its total assets, shows how effectively a company uses its assets to create sales.

Profitability vs. Activity Ratios Ratios

Both activity ratios and profitability ratios are basic analytical techniques that assist investors assess various aspects of a company's financial health. Profitability ratios show how much money a firm makes, whereas efficiency ratios show how well it uses its resources to make that money. Analysts can use profitability ratios to compare a company's earnings to those of its industry competitors, as well as to analyse the same company's success across many reporting periods.