March 17, 2025
9 mins read
Activity ratios are financial metrics that actually tell you if a company’s money and stuff are working hard, or just sitting there looking pretty.
Think of it like this: you’ve got assets (things you own) and liabilities (things you owe). The activity ratio is basically asking, “are you actually using them well enough to make money?” Receivables. Inventory. Total assets. That’s the turf we’re on here.
Now, why should anyone outside a finance department care? Well — investors, analysts, business owners, even curious bystanders use these numbers to size up operational health. Sometimes a high ratio is good. Sometimes it’s a red flag. Sometimes, it’s just noise.
Activity ratios are pretty intuitive once you stop trying to memorise formulas and start thinking about what they mean.
This one’s straightforward: how quickly do you sell and replace your stock?
If you’re running a bakery and your cupcakes vanish the same day you bake them — great, that’s a high turnover. But if trays are still sitting there a week later? That’s low turnover, and possibly stale cupcakes.
In non-bakery terms:
High ratio = you’re moving stock fast (good for cash flow).
Low ratio = stock is gathering dust (bad for space and money).
But — here’s the twist — too high isn’t always a victory. It might mean you’re too lean on stock, missing out on sales because shelves are empty.
How quickly do people pay you back when you sell on credit?
High turnover here means customers settle bills quickly. Your cash flow loves that. But if it’s too high, maybe your credit policy is so strict you’re scaring away potential customers.
Low turnover? That’s the headache zone — late payments, risky customers, and you stuck playing debt collector.
It’s all about balance. Give customers breathing room, but not enough to wander off with your money.
Flip the table — now it’s about how fast you pay suppliers.
Pay too quickly? Suppliers love you, but you might be draining cash that could’ve sat in your account a bit longer.
Pay too slowly? Suppliers get twitchy, maybe even cut off favourable terms.
Some companies delay payments deliberately to hold onto liquidity. Others do it because… well, cash flow’s tight. Only one of those is a good strategy.
This one’s a big-picture lens: how much revenue are you squeezing out of everything you own?
High turnover means you’re using your stuff efficiently. Low turnover… could be inefficiency, or maybe just the nature of your industry.
A manufacturing plant with huge machinery costs will almost always have a lower asset turnover than, say, a freelance graphic designer with a laptop. Context matters.
Additionally Read: What is Ratio Analysis
Let’s be real. They’re not magic numbers. But they do whisper important truths if you listen. Keeps cash flowing – You see where money’s tied up, and how quickly it’s moving in and out of your business.
Helps you plan better – Trends pop out when you track ratios over time. It’s like reading your own business diary.
Guides decision-making – Whether it’s credit terms, supplier deals, or stock orders — these numbers nudge you toward smarter calls.
Win investor trust – Strong ratios make you look reliable, efficient, and worth betting on.
Check your standing – Comparing with industry peers tells you if you’re ahead of the pack or lagging.
Spot true efficiency – See if every rupee of asset or liability is pulling its weight, or just hanging around doing nothing.
The activity ratio depends on the type you want to calculate, each having a specific formula. For total assets turnover:
Total Assets Turnover = Cost of Goods Sold ÷ Average Total Assets
For fixed assets turnover:
Fixed Assets Turnover = Cost of Goods Sold ÷ Average Net Fixed Assets
For working capital turnover:
Working Capital Turnover = Cost of Goods Sold ÷ Average Working Capital
Investors interested in stocks or mutual fund schemes can use these formulas to analyze turnover ratios effectively.
Inventory Turnover=Cost of Goods Sold (COGS)Average Inventory\text{Inventory Turnover} = \frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}}Inventory Turnover=Average InventoryCost of Goods Sold (COGS)
COGS → Found on your income statement.
Average Inventory → (Opening Inventory + Closing Inventory) ÷ 2.
Example: COGS = ₹12,00,000 Average Inventory = ₹3,00,000 Inventory Turnover = ₹12,00,000 ÷ ₹3,00,000 = 4 times
Receivable Turnover=Net Credit SalesAverage Accounts Receivable\text{Receivable Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}}Receivable Turnover=Average Accounts ReceivableNet Credit Sales
Net Credit Sales → Total sales made on credit (exclude cash sales).
Average Accounts Receivable → (Opening Receivables + Closing Receivables) ÷ 2.
Example: Net Credit Sales = ₹8,00,000 Average Accounts Receivable = ₹2,00,000 Receivable Turnover = ₹8,00,000 ÷ ₹2,00,000 = 4 times
Payable Turnover=Total Supplier PurchasesAverage Accounts Payable\text{Payable Turnover} = \frac{\text{Total Supplier Purchases}}{\text{Average Accounts Payable}}Payable Turnover=Average Accounts PayableTotal Supplier Purchases
Total Supplier Purchases → From purchase records (credit only).
Average Accounts Payable → (Opening Payables + Closing Payables) ÷ 2.
Example: Total Supplier Purchases = ₹5,00,000 Average Accounts Payable = ₹1,25,000 Payable Turnover = ₹5,00,000 ÷ ₹1,25,000 = 4 times
Asset Turnover=Net SalesAverage Total Assets\text{Asset Turnover} = \frac{\text{Net Sales}}{\text{Average Total Assets}}Asset Turnover=Average Total AssetsNet Sales
Net Sales → Sales after returns and allowances.
Average Total Assets → (Opening Assets + Closing Assets) ÷ 2.
Example: Net Sales = ₹15,00,000 Average Total Assets = ₹5,00,000 Asset Turnover = ₹15,00,000 ÷ ₹5,00,000 = 3 times
Understanding activity ratios goes way beyond just calculating them. It is all about how well you can determine what they reveal about a company's operational efficiency. Here's how they are interpreted:
A high inventory turnover ratio suggests strong sales and effective inventory management. This further means that the company is not overstocking and has a well-functioning supply chain.
However, if the ratio is too high, it may indicate stock shortages. This may eventually lead to missed sales opportunities. On the other hand, a low ratio could mean slow-moving inventory, or weak demand, or excess stock. In short, this could all tie up capital and eventually increase storage costs.
A high receivables turnover ratio indicates that a company collects all its payments effectively. This reduces the overall risk of bad debts, eventually ensuring a steady cash flow.
However, as stated, an excessively high ratio could also mean the company has strict credit policies that may discourage potential customers. A low ratio suggests delayed payments, potential credit risks, or lenient credit terms. In the end, this can lead to liquidity issues.
A high accounts payable turnover ratio shows that a company pays its suppliers quickly. This strengthens supplier relationships and improves credit terms. However, in case it goes too high, it may indicate poor cash retention.
A low ratio, on the other hand, suggests that the company is taking longer to pay its suppliers. This could also indicate cash flow problems. It is important to create a strategy to maximise available funds before settling liabilities.
A high total asset turnover ratio indicates that a company efficiently uses its assets to generate revenue. This indicates a strong operational performance. A low ratio might suggest underused resources, or the need for better asset management.
Seasonal Fluctuations - Activity ratios can be misleading for seasonal businesses, as turnover changes drastically depending on the time of year analysed.
Industry Variations - Ratios differ widely across industries, making comparisons without understanding sector-specific norms potentially misleading and unhelpful for accurate analysis.
Potential for Manipulation - Companies might alter sales timing, offer discounts, or delay payments to temporarily inflate activity ratios without real operational improvement.
Exclusion of External Factors - These ratios ignore economic conditions, competition, or supply chain disruptions that could significantly impact a company’s operational efficiency and turnover.
Limited Standalone Use - No single activity ratio gives a complete picture; they must be analysed alongside liquidity, profitability, and leverage ratios for accuracy.
Activity ratios are like overhearing snippets of a company’s internal conversations. Useful, revealing — but only part of the story. Sometimes a low number means trouble. Sometimes it’s strategic.
A high number might be efficiency… or a warning sign in disguise. If you’re an investor, use them as your first filter. If you run a business, they’re your early warning system. And if you’re just curious? Well, now you know how to read between the numbers.
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Activity ratios entirely focus on asset utilisation and efficiency. On the contrary, liquidity ratios assess a company's ability to meet short-term financial obligations. Liquidity ratios measure solvency while activity ratios evaluate operational effectiveness.
Activity ratios offer insights into a company's efficiency in terms of managing resources. Investors use them to determine how well a business is converting its assets into sales, which impacts profitability and long-term financial health. A company with strong activity ratios is often more competitive and financially stable.
The inventory turnover ratio is calculated as COGS (cost of goods sold) divided by average inventory. It denotes how frequently a company sells and replaces its inventory within a given period.
A high accounts receivable turnover suggests that a company collects payments from customers quickly and efficiently. This indicates excellent collections, strong credit policies, and good cash flow management. On the other hand, an extremely high ratio means overly strict credit policies that could also limit sales growth.
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