# Activity Ratios - BC Bookkeeping Tutorials|dwmbeancounter.com

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## Activity Ratios

Ratios
Activity (Turnover) Efficiency Ratios
Activity Ratios are financial measurements used to determine how efficient a company’s operations are performing. These ratios should normally be calculated when financial statements are prepared - monthly, quarterly, and annually.
Accounts Receivable Turnover Ratio
• What It Tells Us:  Accounts Receivable Turnover indicates our ability to collect cash from customers. In other words, how efficient the business is at collecting it's credits sales. It's expressed as the number of times receivables are collected for a period.
• Calculation: Net Credit Sales (Sales Billed On Account) for a Period divided by Average Accounts Receivable for a Period
• Formula: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
If the total Net Credit Sales Amount is not available, Net Sales is often used as a substitute although Net Credit Sales is preferred for accuracy
• How Normally Expressed: Decimal Number (Number of Times)
• Bad or Good: Normally, the higher the number the better. A firm that is efficient at collecting on its payments due will have a higher accounts receivable turnover ratio. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A low receivables turnover ratio might be due to an inadequate collection process, bad credit policies, or customers that are not financially viable or creditworthy. Typically, a low turnover ratio implies that the company should reassess its credit policies to ensure the timely collection of its receivables. A ratio calculated for a year of 12.0 tells us that the business collects its receivable 12 times a year.
Example:
 Accounts Receivable Turnover Ratio Information: Dollars in thousands Month Quarter Year Net Credit Sales For Period 60 200 700 Beginning Accounts Receivable For Period 60 60 60 Ending Accounts Receivable For Period 65 70 75 Average Accounts Receivable For Period 62.5 65 62.5 Accounts Receivable Turnover Ratio 1.0 3.1 11.2 Net Credit Sales / Average Accounts Receivable
Our example ratios mean that for the month we had our receivables turnover 1.0 time, for the quarter 3.1 times, and for the year we had a turnover of 11.2 times.
Average Receivables Collection Days (Days Sales Outstanding)
• What It Tells Us: Average Receivables Collection Days measures the average number of days necessary to collect credit sales for a period.
• Calculation: Average Accounts Receivable for a Period divided by Net Credit Sales (Sales Billed On Account) for a Period multiplied by 365 (or period length in days)
If the total Net Credit Sales Amount is not available, Net Sales is often used as a substitute although Net Credit Sales is preferred for accuracy.
• Formula: Average Receivables Collection Days = (Average Accounts Receivable / Net Credit Sales) x 365 (or period length in days)
• How Normally Expressed: Decimal Number (Number of Days)
• Bad or Good: Normally, the lower the number the better. You need to compare this number to the credit terms you offer to your customers. Also, you should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A high number suggests that a company is experiencing delays in receiving payments. This can lead to cash flow problems. A low number indicates that the company is getting its payments quickly. In other words, the company is promptly getting paid by its customers. A number under 45 is acceptable, although depending on credit terms, might need to be investigated for improvements. A ratio of 45 days tells us that it takes us 45 days to convert our receivables into cash. You need to compare this number to your normal credit terms that you grant your customers. If this is net 30, you may need to take action to speed up your collections.
Example:
 Average Receivables Collection Days Information: Dollars in thousands Month Quarter Year Beginning Accounts Receivable For Period 60 60 60 Ending Accounts Receivable For Period 65 70 75 Average Accounts Receivables For Period 62.5 65 62.5 Net Credit Sales For Period 60 200 700 Days 30 90 365 Average Receivables Collection Daysl 31.3 29.3 32.6 Average Accounts Receivable / Net Credit Sales x (30 or 90 or 365)
Our example ratios mean that for the month we collected our receivables in 31.3 days, for the quarter 29.3 days, and for the year 32.6 days.
Inventory Turnover Ratio
• What It Tells Us: Inventory Turnover Ratio measures the number of times inventory is sold for a period.
• Calculation: Cost Of Goods Sold for a Period divided by Average Inventory for a Period
• Formula: Inventory Turnover Ratio = Cost Of Goods Sold / Average Inventory
• How Normally Expressed: Decimal Number (Number of Times)
• Bad Or Good: Normally the higher the number the better. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A slow turnover might indicate weak sales and possibly excess or obsolet inventory, while a faster ratio implies either strong sales or insufficient inventory. As a general rule, businesses selling products that are relatively inexpensive will tend to have higher inventory turnovers and businesses selling expensive products will tend to have lower inventory turnovers. Businsses will normally try to have a high inventory turnover. After all, a high inventory turnover reduces the amount of capital tied up in their inventory, thereby improving their liquidity and financial strength. In addition, maintaining a high inventory turnover reduces the risk that their inventory will become unsellable due to spoilage, damage, theft, or technological obsolescence. A ratio of 12.0 tells us that we are selling our inventory 12 times a period.
Example:
 Inventory Turnover Ratio Information: Dollars in thousands Month Quarter Year Cost Of Goods Sold For Period 40 135 425 Beginning Inventory For Period 35 35 35 Ending Inventory For Period 37 42 39 Average Inventory For Period 36 33.5 37 Inventory Turnover Ratio 1.1 4.1 11.5 Cost Of Goods Sold / Average Inventory
Our example ratios mean that for the month we sold our inventory 1.1 time, for the quarter 4.1 times, and for the year we had a turnover of 11.5 times.
Average Days Of Inventory
• What It Tells Us: Average Days Of Inventory measures the average number of days necessary to sell all inventory for a period.
• Calculation: Average Inventory for a Period divided by Cost Of Goods Sold for a Period multiplied by 365 (or period length)
• Formula: Average Days Inventory = (Average Inventory / Cost Of Goods Sold) x 365 (or period length)
• How Normally Expressed: Decimal Number (Number of Days)
• Bad or Good: Normally the lower the number the better. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A business with a low number has less funds "tied up" in inventory. A ratio of 45 tells us that it takes us an average of 45 days to sell our inventory.
Example:
 Average Days Of Inventory Information: Dollars in thousands Month Quarter Year Beginning Inventory For Period 35 35 35 Ending Inventory For Period 37 42 39 Average Inventory For Period 36 33.5 37 Cost Of Goods Sold For Period 40 135 425 Days 30 90 365 Average Days Of Inventory 27 22.3 31.8 Average Inventory / Cost Of Goods Sold x (30 or 90 or 365)
Our example ratios mean that for the month we sold our inventory in 27 days, for the quarter 22.3 days, and for the year 31.8 days.
Accounts Payable Turnover Ratio
• What It Tells Us: Accounts Payable Turnover measures how quickly a business makes payments to creditors and suppliers that grant them credit payment terms. How many times a company pays off its accounts payable during a period.
• Calculation: Total Net Credit Purchases for a Period  / Average Accounts Payable for a Period
• Formula: Accounts Payable Turnover = Total Net Credit Purchases / Average Accounts Payable
If the total Credit Purchase Amount is not available, Cost Of Goods Sold is often used as a substitute although Net Credit Purchases is preferred for accuracy.
Cost Of Goods Sold / Average Accounts Payable
• How Normally Expressed: Decimal Number (Number of Times)
• Bad or Good: Normally the higher the number the better. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A business with a high turnover ratio pays their suppliers more frequently. A ratio of 10 tells us we paid our supplers 10 times during the period.
Example:
 Accounts Payable Turnover Ratio Information: Dollars in thousands Month Quarter Year Net Credit Purchases For Period 30 140 420 Beginning Accounts Payable For Period 31 31 31 Ending Accounts Payable For Period 32 35 34 Average Accounts Payable For Period 31.5 33 32.5 Accounts Payable Turnovery Ratio 1.0 4.2 13.0 Net Credit Purchases / Average Accounts Payable
Our example ratios mean that for the month we paid our suppliers 1.0 time, for the quarter 4.2 times, and for the year 13.0 times.
Average Accounts Payable Payment Days
• What It Tells Us: Average Accounts Payable Payment Days measures the average number of days that a company takes to pay its suppliers for a period. It indicates how well the company’s cash outflows are being managed.
• Calculation: Average Accounts Payable / Net Credit Purchases x 365 (or period length)
If the total  Net Credit Purchase Amount is not available, Cost Of Goods Sold is often used as a substitute although Net Credit Purchases is preferred for accuracy
• How Normally Expressed: Decimal Number (Number of Days)
• Bad or Good: Normally the lower the better. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Comments: A company with a high number takes longer to pay its bills and provides a source of additional temporary funds. A high number; however, may be be a red flag indicating an inability to pay bills on time. A ratio of 60 days tells us that it takes us 60 days to pay our supplier invoices. You need to compare this number to the normal credit terms that your suppliers grant you. If this is net 30, you may need to take action to speed up your payments or risk being "put" on a Cash on Delivery (COD) basis or even worse lose a supplier.
Example:
 Average Accounts Payable Payment Days Information: Dollars in thousands Month Quarter Year Beginning Accounts Payable For Period 31 31 31 Ending Accounts Payable For Period 32 35 34 Average Accounts Payable For Period 31.5 33 32.5 Net Credit Purchases For Period 30 140 420 Days 30 90 365 Average Accounts Payable Payment Days 31.5 21.2 28.2 Average Accounts Payable / Net Credit Purchases x (30 or 90 or 365)
Our example ratios mean that for the month we paid our payables in 31.5 days, for the quarter 21.2 days, and for the year 28.2 days.
Bad or Good ? Our calculated example ratios need to be compared with the credit terms we grant our customers and the credit terms our suppliers grant us. You should use your financial information to spot trends good or bad and compare to industry averages if available.
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