Activity ratios or operating efficiency ratios deal with the utilization of assets in generating revenues efficiently. These ratios calculate that how efficiently the company is using its assets and reflect the efficient management of working capital and assets. As it has been noted that efficiency has a direct effect on the liquidity, hence these are also useful for analyzing liquidity.
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Interpretation of activity ratios:
Inventory turnover ratio:
This inventory turnover ratio reveals how well inventory is being managed. It is important because the more times inventory can be turned in a given operating cycle, the greater the profit. A high inventory turnover ratio relative to the standards shows highly efficient inventory management and the low inventory turnover ratio shows slow moving inventory.
Debtor’s turnover ratio:
A business is concerned with the debtor’s ratio as this ratio will tell that how long the credit customers take to pay the amounts owed to the company. This ratio also tells that how well the company is in collecting the amounts from the credit customers (Joseph E Palmer, 1983). A relatively high turnover ratio to the industry indicates efficient credit and collection and a low turnover raise questions concerning about the credit and collection policies.
Asset turnover ratio:
The asset turn over ratio gives an idea about how well the company is using its assets in generating revenues. A low asset turnover ratio tells about the inefficiency regarding the utilization of assets in generating revenues.
An analyst when determining the activity of the company he should analyze not only the individual but also the collection of the ratios relative to the industry.
M C Shukla. (1999). “advanced accounting.” Liquidity ratios. INDIA: S Chand and Company.
Joseph E Palmer. (1983) financial ratio analysis: efficiency ratios. New York: American Institute of Certified Public Accountants.
Erich A Helfert. (2001). financial analysis tools and techniques: a guide for managers. New York: McGraw-Hill.