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What are the types of Activity ratio or Turnover ratio?

Activity ratio or Turnover ratio: The ratio shows that how efficiently company converted its resources into cash in time.

Working Capital Turnover ratio: It shows how efficiently company uses the working capital to meet day to day needs and generate sales. Higher the ratio better for the company. This ratio is uses in non-manufacturing company.

Working Capital turnover = Cost of goods sold / Working capital

Working capital = Current assets – current liabilities

Cost of goods sold = Opening stock + Purchases + wages + Carriage inward + other direct expenses – Closing stock

Inventory turnover ratio: It shows how efficiently company converted its stock into sales. High ratio is better for the company because it shows less maintenance of inventory.

Inventory Turnover ratio = Cost of goods sold / Average Stock

Average stock = (Opening stock + Closing stock) / 2

Example: Find out the inventory turnover ratio:

Sales
5, 00,000
Gross profit
1, 80,000
Operating expenses
90, 000
Opening stock
60, 000
Closing stock
20, 000

Solution:
Cost of goods sold = Sales – Gross profit
= 5, 00,000 – 1, 80,000
= 3, 20,000
Average stock = (60, 000 + 20, 000) / 2
= 40, 000
= 3, 20,000 / 40, 000
= 8:1
This ratio shows that the company no need to maintain the inventory for long period.

Fixed assets turnover ratio: This ratio is mostly uses in manufacturing company. It shows how efficiently company uses its fixed assets to meet its long term requirement.Higher the ratio better for the company.

Fixed assets Turnover ratio = Cost of goods sold / net fixed assets

Net fixed assets = Fixed assets – Depreciation

Current assets turnover ratio: It shows that how efficiently company uses its current assets to generate sales to meet its cash requirement. Higher the ratio better for the company.

Current assets turnover ratio = Cost of goods sold / current assets

Example: Find out the working capital turnover ratio and fixed assets turnover ratio:

Total assets
Rs. 10, 60,000
Current assets
Rs. 3, 70,000
Current liabilities
Rs. 2, 00,000
Current assets turnover ratio
4:1

Solution: Cost of goods sold = Current assets turnover ratio * Current assets
= 4*3, 70,000 = 14, 80,000
Working capital = Rs. (3, 70,000 – 2, 00,000)
= Rs. 1, 70,000
Working capital turnover ratio = 14, 80,000 / 1, 70,000
= 8.71:1
Fixed assets = Rs. (10, 60,000 – 3, 70,000)
= Rs. 6, 90,000
Fixed assets turnover ratio = 14, 80,000 / 6, 90,000
= 2:1
The working capital is efficiently uses in a company but the fixed assets are not utilising properly.

Debtors Turnover ratio: It tells how quickly debtors are converted into cash. If the ratio is high then debtors are easily paid money.

Debtors Turnover ratio = Net credit sales / average debtors + Average B/R

Average Debtors = (Opening debtors + Closing debtors) / 2

Average B/R = (Opening B/R + Closing B/R) / 2

Average Collection Period: It tells about the days in which the debtors are made their payments.

Average Collection Period = 365 / Debtors turnover ratio

Example: A Company XYZ sell 25, 000 units @ Rs. 70 per unit. But only 85% units were sold in cash. The company has Rs. 60, 000 opening balance of bill receivable. Find out how quickly the debtors are converted into cash?

Solution: Credit sales unit = 25, 000 * 0.15 = 3, 750 units
Credit sales = 3, 750 * 70 = 2, 62,500
Average B / R = 60, 000 + 0 / 2 = 30, 000
Debtors Turnover ratio = Net credit sales / average debtors + Average B/R
= 2, 62,500 / 30, 000
= 8.75:1
The ratio 8.75:1 shows that debtors are converted into cash easily.

Creditors Turnover ratio: It shows that how quickly the company make payments to creditors. High ratio shows company take less time to make payments to creditors.

Creditors Turnover ratio = Net credit purchases / Average creditors + Average B/P

Average Creditors = (Opening creditors + Closing creditors) / 2

Average B/P = (Opening B/P + Closing B/P) / 2

Average Payable Period: It tells about how many days required by a company to make their payments.
Average Payable Period = Days in a year (365) / creditors turnover ratio

Example: Find out the credit worthiness of company Y and Z. The credit turnover ratios of two companies are 6:1 and 7:2 respectively.

Solution:  Company Y average payable period = 365 / 6
= 60
Company Z average payable period = 365 / 3.5
= 104
So, in 44 days earlier company Y make payment to their creditors in comparison to Company Z.





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