Define: Activity Ratios

Activity ratios are financial ratios that measure a company’s efficiency in managing its assets and resources to generate sales and revenue. These ratios provide insights into how effectively a company is utilizing its assets to generate sales and how quickly it is converting its assets into cash.

Commonly used activity ratios include inventory turnover ratio, accounts receivable turnover ratio, and accounts payable turnover ratio. The inventory turnover ratio measures how quickly a company sells its inventory and is calculated by dividing the cost of goods sold by the average inventory. A higher ratio indicates efficient inventory management.

The accounts receivable turnover ratio measures how quickly a company collects its accounts receivable and is calculated by dividing net credit sales by the average accounts receivable. A higher ratio indicates effective credit and collection policies.

The accounts payable turnover ratio measures how quickly a company pays its suppliers and is calculated by dividing the cost of goods sold by the average accounts payable. A higher ratio indicates efficient payment management.

Activity ratios are important for investors and creditors as they provide insights into a company’s operational efficiency and financial health. By analyzing these ratios, stakeholders can assess a company’s ability to generate sales, manage inventory, collect receivables, and pay its suppliers.

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This glossary post was last updated: 29th March 2024.