How Activity Ratios Can Help Your Business
Using activity ratios to measure your organization’s performance is a valuable tool for determining how well-managed you are. In general, a well-managed organization utilizes its resources efficiently while maximizing its revenue. Here are some examples of common activity ratios. Best-managed companies continually improve these ratios and continue to look for ways to further enhance their business. For example, a high activity ratio often indicates a company’s tendency to sell only a limited number of items and implement conservative payment terms. Another example would be aggressively collecting overdue invoices.
Total asset turnover ratio
To calculate the total asset turnover ratio, you need to have two basic pieces of information in order to calculate it. These numbers are net sales and average total assets. If you don’t know either of these numbers, use an accounting program or sales journal to find out. To calculate the ratio, divide net sales by total assets. Total asset turnover is the ratio of net sales divided by total assets. Then divide this number by 100 to get the ratio.
The higher the ratio, the better, but there’s no exact science behind it. For example, some industries have a higher total asset turnover ratio than others. Using industry standards helps determine how effective the company is in using assets. Some industries utilize assets more efficiently than others, so comparing two companies’ ratios will provide an accurate picture of the efficiency of each company’s assets. In the next section, we’ll discuss some other ways to calculate the total asset turnover ratio.
Accounts receivable turnover ratio
The accounts receivable turnover ratio is important to understand when it comes to your business’s cash flow. While good customer service and strong sales will be vital for a healthy cash flow, a low ratio could be an indication of poor management. In any case, it is important to look at your ratio on a regular basis to see how you can improve it. Below are some tips for evaluating your company’s accounts receivable turnover ratio.
First, calculate your accounts receivable turnover ratio. Your current ratio should be higher than your industry average. This means that a company with a lower AR turnover ratio is less likely to be successful than one with a high ratio. A low AR turnover ratio may indicate a need to adjust your credit or collection policies. If the ratio remains low, this could negatively affect your cash flow and negatively impact your business’s profitability. To improve your AR turnover ratio, you should implement automation in your invoicing process.
Fixed asset utilization ratio
A company’s fixed asset utilization ratio is a vital measure of its profitability. Too little fixed asset use can lower a firm’s profit margin. This ratio can also be affected by rapidly changing prices. Companies with older equipment may experience higher turnover than those with newer equipment. But there are several ways to improve fixed asset utilization. Here are three ways to increase your fixed asset utilization ratio. Let’s examine each of them to help your business grow!
The denominator will be lower than the numerator if a company is not investing in new fixed assets. When the denominator keeps declining, this is a bad sign because it can hinder future growth opportunities. Old assets may have no book value left after accumulated depreciation, so the company’s net revenue may be higher than its fixed asset utilization ratio. This can make the company look more expensive than it is.
Inventory turnover ratio
The Inventory turnover ratio in activity-ratio calculations is often calculated by dividing the cost of goods sold by the average inventory. The turnover ratio is a valuable indicator of how effectively a company controls its inventory. A high turnover ratio suggests strong sales, but it can also reflect poor inventory management. A high inventory turnover ratio indicates that a company needs to increase its orders to suppliers, since low inventory turnover can limit its ability to make sales.
The DOH or cost of goods sold ratio is a better indicator of inventory turnover than sales. It allows companies to compare their own inventory with those of competitors, since different companies would apply different markups on sale prices. A high DOH would overstate a company’s actual inventory turnover. Because a seasonal business varies its inventory during different periods, it is common for the ratio to fluctuate, depending on how much inventory a company is storing. For these businesses, the average cost of inventory is used as the denominator.