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Definition: Activity Ratios
Activity Ratios are used by businesses to figure out how soon they can convert their assets into cash. Activity ratios are used to measure the efficiency of a firm. This is important to know for example if a company needs to know how fast they can access their cash so that the bills can be paid. Businesses also need to know the efficiency of their business processes which can be done using activity ratios.
Assets are generally classified into two: fixed and current assets. Current Assets are those which can be converted into cash in a short period of time. For example, inventory or accounts receivable. Fixed Assets are those which take longer to convert into cash. For example, land, machinery or equipments.
There are several activity ratios like inventory turnover and average collection period.
1 Inventory Turnover = Cost of goods sold (COGS) / Average inventory
For example, for a company COGS is $700,000, while the average inventory for the same period is $70,000. Therefore, the inventory turnover is 10. To see how efficient the company is at inventory turnover, the rate is compared with the competitor.
2 Average Collection Period = Accounts Receivable * days (365) / credit sales
A company has $10000 in Accounts Receivables and $150000 in sales. The average collection period for its Account Receivables is : $10000*365/ $150000 = 24.3 or 24 days.