ACTIVITY RATIOS

Liquidity of Receivables >>

Financial Statement Analysis-FIN621

Lesson-34

ACTIVITY RATIOS

Activity Ratios also known as efficiency or turn over ratios, measure how effectively the firm is

using its assets. Some aspects of activity analysis are closely related to liquidity analysis. Our

focus is to attention on how effectively the firm is managing two specific asset groups-

receivables and inventories- and its total assets in general.

iii)

Working capital: It depends upon the size and nature of business. Arithmetically it is

the difference of Current Assets and Current Liabilities. Two companies with same

working capital can have different current ratios. Similarly two companies may have

same current ratio but different working capital.

iv)

Quality of Working Capital:

(A) Liquidity of inventory:

To help determined how effectively the firm is managing inventory (and also to gain an

indication of the liquidity of inventory) we compute the inventory turn over ratio. This ratio,

like other ratios, must be judged in relation to ratios of similar firms, the industry average or

both

Generally the higher the inventory turn-over , the more efficient the inventory management of

the firm and the "fresher" more liquid, the inventory and vice versa.

It shows how quickly inventory is sold and is determined by Inventory Turnover Ratio

(ITO). It is the number of times the company sells (turns over) it inventory during the year.

Inventory Turnover Ratio (ITO) = Cost of good sold for the year____

= 60 = 3

Average inventory during the year

The higher the rate, the more quickly the company sells its inventory. However, companies selling high

markup items e.g. Jewelry Stores, F-16 can operate successfully with much lower ITO.

Days required to sell inventory: i.e.

Converting inventory into Receivables = 365 or 300 = 365 or 300 = 122 or 100

ITO

132

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