Activity ratios, also known as asset utilization ratios or operating efficiency ratios, are measures of operational performance — how effectively the company is using working capital and longer term assets.
Interpretation of Activity Ratios
Inventory Turnover and DOH
Inventory turnover indicates the resources tied up in inventory (i.e., the carrying costs) and, therefore, can be used to indicate inventory management effectiveness. In general, inventory turnover and DOH (days of inventory on hand) should be benchmarked against industry norms.
Receivables Turnover and DSO
The number of DSO (days of sales outstanding) reflects how fast the company collects cash from customers to whom it offers credit. Although limiting the numerator to sales made on credit in the receivables turnover would be more appropriate, credit sales information is usually not available to analysts; therefore, revenue as reported in the income statement is generally used.
Payables Turnover and the Number of Days of Payables
The number of days of payables reflects the average number of days the company takes to pay its suppliers, and the payables turnover ratio measures how many times per year the company theoretically pays off all its creditors.
Working Capital Turnover
Working capital turnover indicates how efficiently the company generates revenue with its working capital.
Fixed Asset Turnover
This ratio measures how efficiently the company generates revenues from its investments in fixed assets. Generally, a higher fixed asset turnover ratio indicates more efficient use of fixed assets in generating revenue. A low ratio can indicate inefficiency, a capital-intensive business environment, or a new business not yet operating at full capacity—in which case the analyst will not be able to link the ratio directly to efficiency. In addition, asset turnover can be affected by factors other than a company’s efficiency.
Total Asset Turnover
The total asset turnover ratio measures the company’s overall ability to generate revenues with a given level of assets.
