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What is Activity Analysis Ratio?

Its an example to accounting ratio. It is a metric that reveals how well a business uses the assets shown on its trial balance to generate income and cash flow. It shows how efficiently management is using the company's resources to generate the maximum amount of income possible. Activity ratios are used by analysts to compare businesses in the same sector. They also employ it to assess the long-term financial stability of a single business.

Activity ratios can is basically used for comparing two companies operating in the same industry or to track the financial health of a single organization over time.

General interpretation for Activity Analysis Ratio 

A higher value to this ratio indicates that a business is operating profitably because it shows that the company is making more money for every dollar invested in assets. A poor ratio, on the other hand, suggests that a corporation is not making effective use of its assets and may be going through internal difficulties. Also, whenever one wants to have investors or persons or organizations who can sponsor your business will only do so if the ratio is high stating that the business is economically and strategically sound and is using its resources efficiently. The industries will always oversee high turnover ratio than other factors. For example in small business, they use small assets but still have high sales which results in high turnover ratio. In contrast, industries or factories require high investment, high assets with low sales and the turnover ratio appears to be less.

Types of Activity Analysis Ratios 

1. Total Assets Turnover Ratio: It measures how effectively a corporation uses its assets. Ratio having a higher gradation shows that all resources are being utilized effectively to produce sales. Investors can use this measure to gauge how effectively organizations use their resources to generate income. Investors compare businesses in the same industry or group using this type of ratio. Generally it is affected by the rate of purchase and sales done in a year.

2. Fixed Assets Turnover Ratio: How effectively a business earns profit from its current property and equipment is gauged by this type of activity analysis ratio. A greater ratio shows that management is using its fixed assets more effectively. For investors seeking investment opportunities in sectors with wealth firms, it may be useful in assessing and tracking the gain they received on their investments.

3. Working Capital Turnover Ratio: A company's ability to utilize its cash flow to sustain a specific level of sales is measured under this ratio. If calculation to this ratio comes high it shows that management is utilizing its assets and fulfilling its duties to the fullest extent possible in order to increase sales. In case of vice versa to this, it indicates that a business is spending too much on inventory to support its sales which may put the person in debt scenario. The mere difference between what a firm holds and its duty charges is known as the working capital of that firm.

4. Stock Turnover Ratio: This indicates as to how much of the organizations stock has been sold out. Inventory turnover ratio is defined as how much of the inventory is being sold during the specific time period taken. If this comes to be high it means strategically the business is being run efficiently with proper inventory management and good sales but in case the ratio comes low it indicates the situation that the organization is not favourable as per public demand.

5.Debtors or Accounts Receivable Ratio: The ability of an organisation to receive funds from its clients is determined by this ratio measure. The mean ratio value obtained during a certain time period is multiplied by total value of sales of the organization. A low ratio indicates a problem with the collection procedure.

6. Return on Equity (ROE): The earnings generated from capital employed are measured by a performance indicator called ROE. Net earnings are calculated by dividing by the total number of current shares available on the market.

Comparison between Activity ratio and Probability ratio

Fundamental analytical methods assist investors in assessing many dimensions of a company's financial health. Efficiency testing ratios assess how effectively a corporation uses its assets to generate profits, whereas profit assessing ratios show how much money a company makes. The latter can assist analysts in comparing a firm's income with its competitors in the same sector and analyzing the development of the organization for a long more follow up period.

Difference between asset turnover ratio and fixed asset ratio

The goal for both is same but the methods are different. The goal is to analyze whether the business is working efficiently or not or the assets are being properly or not. The main difference is in the fixed assets the organization do calculate how much it earns using its whole assets while in the other approach the net profit is calculated on the basis of average assets. Name indicates in fixed asset ratio we use fixed assets only to calculate profit while in the other all the company's assets are used for the same purpose.

Limitations by calculating this ratio 

  • A business may purchase significant quantities of things in expectation of future expansion, which could result in false increment or negative results. In contrast selling assets in anticipation of slowing growth will cause the ratio to increase drastically.
  • Seasonality has a significant impact on the ratio because the numbers substantially shift over the year.
  • Because a company's ratio might vary significantly in different years, it is crucial to examine patterns in the data to see if it is rising or falling.
  • Getting huge profits or high turnover ratio is not an actual indicator to guess about the business growth. The only mere point to be considered is how much net profit one can gain after selling his/her goods.
  • Despite gaining less profit in comparison to the competitors still this shows high asset turnover ratio giving us false predictions.

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