# Activity Ratios  ## Activity Ratios Definition

Activity Ratios refers to the type of the financial ratios which are used by the company in order to determine the efficiency with which the company is able to use its different operating assets that are present in its balance sheet and convert the same into the sales or the cash.

Activity ratios help in evaluating a business’s operating efficiency by analyzing fixed assets, inventories, and accounts receivables. It not just expresses a business’s financial health but also indicates the utilization of the balance sheet components.

• Activity Ratios do not give the desired output when comparing businesses across different industries.
• The more common term used for activity ratios is .
• Activity ratio formulas also help analysts to analyze the business’s current or short term performance.
• An improvement in the ratios depicts improved .

The most common types of Activity Ratios are as follows –

For eg:
Source: Activity Ratios (wallstreetmojo.com)

All these ratios quantify the operations of a business using numbers from the business’s or liabilities.

### Types of Activity Ratios with Formulas & Examples

Depending on the type of business and to arrive at decisions, various Activity Ratios can be used. Let us now look at activity ratios with formulas and examples.

#### #1 – Inventory Turnover Ratio

For a business that holds inventory, this activity ratio formula shows how many times the inventory has been sold out completely in .

Inventory Turnover Ratio = / Average Cost of Inventory
##### Example:

The cost of goods sold for Binge Inc is \$10,000, and the cost is \$5,000. The Inventory Turnover Ratio is calculated as below:

= \$10,000 / \$5,000

Inventory Turnover Ratio = 2

It means that the inventory has been sold out twice in a fiscal year. In other words, it takes 6 months for Binge Inc. to sell its entire inventory. Too much cash into inventories is not good for a business; hence, necessary measures need to be taken to increase the inventory turnover ratio.

#### #2 – Total Assets Turnover Ratio

Total Assets Turnover Ratio calculates the net sales in comparison with its total assets. In other words, it depicts the ability of a business to generating revenue. It helps investors to understand the efficiency of businesses in generating revenue using their assets.

Total Assets Turnover Ratio = Sales / Average Total Assets.
##### Example:

PQR Inc. generated revenue of \$8 billion at the fiscal year-end. The total assets at the start of the year were \$1 billion and, at the end of the year, \$2 billion.

Average Total Assets = (\$1 billion + \$2 billion) / 2

= \$1.5 billion

Total Assets Turnover Ratio is calculated as below

= \$8000000000 / \$1500000000

Total Assets Turnover Ratio = 5.33

A higher Total Asset Turnover Ratio depicts the efficient performance of the business.

#### #3 – Fixed Assets Turnover Ratio

Fixed Assets Turnover Ratio measures the efficiency of a business in utilizing its fixed assets. It shows how the fixed assets are being utilized by the business to generate revenue. Unlike the total Assets turnover ratio that focuses on the total assets, the fixed assets turnover ratio focuses only on fixed assets of the business being utilized. When the fixed assets turnover ratio is declining, it is a result of over-investment in any like plant or equipment, to name a few.

Fixed Assets Turnover Ratio = Sales / Average Fixed Assets.
##### Example:

Net sales of Sync Inc. for the fiscal year were \$73,500. At the beginning of the year, the net fixed assets were \$22,500, and after depreciation and addition of new assets to the business, the fixed assets cost to \$24,000 at the end of the year.

Average Fixed Assets = (\$22,500 + \$24,000) / 2

Average Fixed Assets= \$23,250

Fixed Assets Turnover Ratio is calculated as below

= \$73,500 / \$23,250

Fixed Assets Turnover Ratio = 3.16

#### #4 – Accounts Receivables Turnover Ratio

Turnover Ratio depicts how good a business is at giving credit to its customers and collecting debts. For calculating the accounts receivables turnover ratio, only the are taken into consideration and not the cash sales. A higher ratio indicates that the being paid by the customers on time, which helps to maintain the cash flow and payment of the business’s debts, employee salaries, etc. on time. It is a good sign when the accounts receivables turnover ratio is on the higher side since the debts are being paid on time instead of writing them off. It shows a healthy business model.

Account Receivables Turnover Ratio = / Average Accounts Receivables.
##### Example:

Roots Inc. is a supplier of heavy machinery spare parts, and all of its customers are major manufacturers, and all of the transactions are carried out on a credit basis. The net credit sale for Roots Inc. for the year ended was \$1 million and the average receivables for the year were \$250,000.

The accounts receivables turnover ratio can be calculated as below

= \$1,000,000 / \$250,000

Account Receivables Turnover Ratio = 4

It means that Roots Inc. is able to collect its average receivables 4 times a year. In other words, the average receivables are recovered every quarter.