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What is activity ratio?

What do you understand by the term activity ratio?

Definition: This is the gauge used by an organization to establish the level of efficiency with which different operating assets in the business can be utilized to generate net sales.

Unlike in the case of profitability ratio, activity ratio is more specific for the management is looking forward to establish if the resource used can meet the expected speed of generating net sales.

Note this, sales is the quantity demanded of a good or service from the Economics viewpoint. But you see, the quantity demanded should be produced using the company specific resources and this s the rationale behind reviewing them in a critical manner. Therefore, activity ratio can be looked at through diverse eye lenses as follows;

  1. Contribution made by capital employed to sales 

    To what extent does capital employed aid in translating the business endeavors in to sales? This calls for comparing the proportion of  capital employed to net sales realized within a specific period of time.-capital turnover ratio

  2. Contribution made by total asset to sales

     In this aspect, the management wish to look at the total resources of both non-current and current assets used in generating sales  for the  business. Therefore, total asset turnover ratio is more appropriate to estimate this endeavors

  3. Contribution made by Non-current asset to sales

     In this case, we focus on the input the fixed assets of the business add in to the business as far as sales are concerned. We will look  at  Non-current asset turnover Ratio

  4. Contribution made by Net current asset to sales

    Current assets is also referred to as working capital and it is the excess of current assets over current liabilities. The contribution the excess current assets to sales can be estimated using net current turnover ratio

  5. Contribution made by inventory to sales

     Inventory is a component of current assets and it contributes towards sales in diverse ways. Availability of inventory assures the     management that sales are guaranteed and hence no loss of market share to the competitors. Also, investment in inventory is a   way of ensuring that net profit is not over exaggerated and on the same breath, sales is not over eroded especially when we want   to determine  gross profit at the end of the year. There are other many ways that inventory contribute to sales which culminates in   to the efficiency level portrayed by the inventory turnover ratio discussion

  6. Contribution made by Debtors to sales

     Debtors arise due to sale of goods or products on credit. Debtors are classified as current assets. Sometimes referred to as trade    receivables. The rate at which this current assets are converted in to cash and to debtors again dictate the level of sales of the   company.This is portrayed by the debtor turnover ratio.

  7. Contribution made by Creditors’ to purchases

    Creditors arise due to purchase of goods or products on credit. Creditors are classified as current liability. Sometimes referred to as trade payables. The rate at which these current liabilities are converted in to cash payments and to creditors again dictate the level of purchases of the company.This is depicted by the creditors’ turnover ratio

About the Author - Dr Geoffrey Mbuva(PhD-Finance) is a lecturer of Finance and Accountancy at Kenyatta University, Kenya. He is an enthusiast of teaching and making accounting & research tutorials for his readers.