Saturday, December 4, 2010
Activity Ratios
Activity Ratios or Efficiency Ratios are used to measure the effectiveness of a firm’s use of resources. Good companies would always put their resources to optimum utilization. Better the activity or efficiency ratio, the better it is for the company and it means the company is utilizing its resources properly and effectively.
The ratios that come under this category are:
1. Average Collection Period
2. Degree of Operating Leverage
3. Days Sales Outstanding Ratio
4. Average payment period
5. Asset Turnover Ratio
6. Stock Turnover Ratio
7. Receivables Turnover Ratio
Let us take a look at these ratios in a little bit more details.
Average Collection Period:
Most organizations make sales on credit. They usually deliver goods/services to their customers without taking the payments due immediately. There could be a credit cycle understanding between them and their customers who would make periodic payments for the goods/services rendered to them. This ratio is used to calculate the efficiency with which an organization is able to collect the payments due to them from their customers.
Formula:
ACP = Accounts Receivable / (Annual Credit Sales / 365 days)
Here, only credit sales are taken into consideration. Cash sales that are settled immediately are not considered for this calculation.
Degree of Operating Leverage:
DOL is a ratio that is used to identify the changes in the operating leverage that a company requires with growth in sales and income. As and when a company grows and its sales increases, the operating costs also increase and the operating leverage required by the promoters also changes. This ratio helps us identify that value.
Formula:
DOL = Percentage Change in Net Operating Income / Percentage Change in Sales
Days Sales Outstanding Ratio:
The DSO ratio is a financial ratio that illustrates how well a company’s accounts receivables are being managed. Here accounts receivables refer to the amount of money due to the company for the services/goods provided to its customers.
Formula:
DSO = Accounts Receivable / Average sales per day or
DSO = Accounts Receivable / (Annual Sales / 365)
Average Payment Period:
Average Payment Period is the total opposite of the Average Collection Period. This is the average time taken by the company to pay off its credit purchases.
Formula:
APP = Accounts Payable / (Annual Credit Purchases / 365)
Asset Turnover:
Asset Turnover is a financial ratio that measures the efficiency of a company’s use of its assets in generating revenue or income for the company. A higher asset turnover ratio implies that the company is operating efficiently and is able to generate solid revenue income using the assets at their disposal.
Formula:
Asset Turnover = Sales / Average Total Assets
Stock Turnover Ratio:
Also called the Inventory Turnover Ratio, this is a measure of the number of times inventory is sold or used in a time period corresponding to the average inventory held by the company. This ratio can help us determine how efficiently the company is using its inventory (raw materials) to generate revenue and income. i.e., how quickly is the company able to transform the inventory into finished goods that can be sold and generate an income.
A high turnover rate means that the company is utilizing its available inventory effectively but a very high value may cause risks of inadequate inventory levels. Whereas, a low turnover rate means that the company is overstocking or there are deficiencies in the production strategies.
Formula:
STR or ITR = Total cost of goods sold / Average Inventory
Receivables Turnover Ratio:
The Receivables turnover ratio is used to measure the number of times on an average; the receivables are collected during a particular timeframe. A good receivables turnover ratio implies that the company is able to efficiently collect its receivables.
Formula:
RTR = Net Credit Sales / Average Net Receivables
Labels:
Asset Turnover Ratio,
Average Collection Period,
Average payment period,
Days Sales Outstanding Ratio,
Degree of Operating Leverage,
Receivables Turnover Ratio,
Stock Turnover Ratio
Subscribe to:
Post Comments (Atom)
© 2013 by www.anandvijayakumar.blogspot.com. All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.
Followers
Popular Posts
-
In one of the older posts titled Using a Bank Cheque we had taken a look at what a Cheque is, how to issue a cheque and the things to reme...
-
Almost all of us are working for a company and we contribute a small percentage of our monthly salary into our EPF accounts. We all know t...
-
With the Financial Year winding to a close by end of March and Summary Vacations on the horizon in April-May, many of us are planning ou...
-
In the past few articles in our blog, we had taken a detailed look at the Employee Provident Fund Scheme of India. After reading it, I am ...
-
With the Bull Market in full swing, Insurance Agents and Bank Officials have started convincing investors that ULIPs are the best way to g...
-
One of the biggest points for confusion for most of us is about the Income Tax Aspects surrounding our House. Whether you live in a rented...
-
Public Provident Fund or PPF is one of the most preferred means of Investment as well as Tax Saving in India. As we are entering into the ...
-
One of the most popular articles in my blog is about withdrawal of Employee Provident Fund money from our own EPF Accounts. Usually when ...
-
Are you an avid stock market investor? Do you have a sound stock market portfolio? We all know what a Nominee is – someone who gains possess...
-
We all know what an IPO is and what the purpose of an IPO is for the company issuing the share. But, not many of us know the different req...
Important Disclaimer
All the contents of this blog are the Authors personal opinion only and are not endorsed by any Company. This website or Author does not provide stock recommendations. The purpose of this blog is to educate people about the financial industry and to share my opinion about the day to day happenings in the Indian and world economy. Contents described here are not a recommendation to buy or sell any stock or investment product. The Author does not have any vested interest in recommending or reviewing any Investment Product discussed in this Blog. Readers are requested to perform their own analysis and make investment decisions at their own personal judgement and the site or the author cannot be claimed liable for any losses incurred out of the same.
No comments:
Post a Comment