Types of Activity ratios
Based on various types of assets, the activity ratio has been classed into the following types:
- A debtor or receivable turnover ratio plus average collection period – It specifies the frequency of change from a debtor to cash in one year. Additionally, it suggests the liquidity of debtors’ extent. The average collection period provides a time period when the debtors get changed into cash. Actually, both the ratios specify a similar thing but in dissimilar terms.
- Stock or inventory turnover ratio – Inventory turnover ratio does indicate the number of times an inventory is sold plus substituted in a financial year. To put it into other words, this ratio provides the occurrence of a change of inventory into cash. Commonly, a higher ratio is viewed as good because it symbolizes improved inventory management.
- Assets turnover ratio – This ratio does calculate the revenue’s value which is achieved/dollar of investment. When there is a higher ratio then it symbolizes improved asset management plus utilization. The ratio is also dependent on the business according to their margin of profit.
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What can You Know from Activity Ratios?
Commonly, companies attempt to change their production into sales or cash fast as it will result in higher revenues. This is why; analysts do perform fundamental analysis through the use of common ratios, like activity ratio. The job of activity ratio is measuring the amount of resources which has been invested in the collection of a company plus inventory management.
As businesses commonly operate through the use of inventory, materials, and debt, activity ratios do determine the process in which organizations manage these areas. Activity ratios also turn helpful in measuring the profitability and operational efficiency of an organization and these ratios are highly useful compared to an industry or competitor to create whether or not an entity’s procedures are satisfactory or disapproving.
Distinguishing Activity Ratios from Profitability Ratios
Both activity ratios, as well as profitability ratios, are considered tools that are utilized in fundamental analysis. They help investors in making investment decisions and each of these two tools indicates something diverse regarding a business. The task of profitability ratio is depicting the amount of profit that a company has been generating. On the other hand, activity ratios do measure how efficiently a company uses its resources for generating a profit.
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