Activity ratios are financial metrics used to evaluate how effectively a company is using its resources to generate revenue. There are several types of activity ratios, including the inventory turnover ratio, accounts receivable turnover ratio, and accounts payable turnover ratio.
To calculate the inventory turnover ratio, divide the cost of goods sold by the average inventory value. The formula is:
Inventory turnover ratio = Cost of goods sold / Average inventory
For example, if a company has a cost of goods sold of $500,000 and an average inventory value of $100,000, the inventory turnover ratio would be 5 ($500,000 / $100,000).
To calculate the accounts receivable turnover ratio, divide net credit sales by the average accounts receivable balance. The formula is:
Accounts receivable turnover ratio = Net credit sales / Average accounts receivable
For example, if a company has net credit sales of $1,000,000 and an average accounts receivable balance of $200,000, the accounts receivable turnover ratio would be 5 ($1,000,000 / $200,000).
To calculate the accounts payable turnover ratio, divide the cost of goods sold by the average accounts payable balance. The formula is:
Accounts payable turnover ratio = Cost of goods sold / Average accounts payable
For example, if a company has a cost of goods sold of $500,000 and an average accounts payable balance of $100,000, the accounts payable turnover ratio would be 5 ($500,000 / $100,000).
Overall, activity ratios can help investors and analysts evaluate a company’s efficiency and effectiveness in using its resources to generate revenue.