Interpretations of activity ratio''s, Financial Management

Activity Ratio's

 

RT:           The Receivables Turnover ratio is the ratio between sales to accounts receivables. This says exactly how fast a company can collect on the sales. This actually means that a company collected its outstanding credit amounts and re-loaned the money the calculated times during the year.

 

ACP:        The Average Collectible period or the Days' sales in receivables period is calculated when we convert the receivables turnover ratio to days i.e. 365 days (a year) to the receivables turnover ratio. It tells us the average on which the company collects its credit sales from the purchasers. Larger the credit period, poorer is the collection and in such case immediate steps are essential to collect the outstanding. Normally, 2 to 3 months credit is allowed in competitive market although it may vary from industry to industry, whereas in monopoly, credit period is much shorter.  

 

IR:            The Inventory Turnover ratio or the Stock Turnover ratio is the ratio between Cost of Goods Sold and Inventory and reveals the velocity of the movement of goods during the year i.e. the number of times, the stock is turned over during the year. Higher ratio is the indication of expansion of business provided the company does not run out of stock and thereby forego sales. It signifies the quick movement of the inventory and proves the efficiency of the management in inventory control. Poor ratio on the other hand displays bad buying, accumulation of slow moving stock or obsolete stock etc. concern with high stock turnover ratio may fix up selling price at a smaller gross profit margin, but too high ratio stands for a case of over trading.

 

ICP:         The Inventory Conversion period or the days sales in inventory is calculated when we convert the inventory turnover ratio to days i.e. 365 days (a year) to the inventory turnover ratio. It tells us the average days on which the inventory sits before it is sold.

 

OC:          The Operating Cycles is the total of Inventory Conversion period and the Average Collectible period. This represents the period, which starts from the first level of production, the raw material gets converted to finished goods, get sold and the credit sales is collected and the money comes back to the original stream. It is very crucial for a company to know its operating cycle, which helps in extensive financial planning.

 

OCP:        The Operating Cycles period is the number of times the company rotate its operating period. This is calculated when we convert the operating cycles to number of days i.e. 365 days (a year) to operating cycles. It tells us the average days on which the whole cycle gets rotated.

 

APP:        The Average Payable period or Creditors velocity ratio is calculated by accounts payable to raw material purchased and is then multiplied by 365 days to get it converted to the period in a year. It shows how many days a company is enjoying credit facilities from its creditors. Higher ratio is a sign of overtrading. Most conventional ratio is 2 to 3 months although it may vary from industry to industry.

 

OC-APP: The Operating Cycles period less the Average Payable period is the period where a company or an organization needs to borrow funds from outside or in other words is the period where Working Capital is required to fund the operation. This is where a company needs an alternative way of funding.

 

Sales/Assets ratio:       This is the study between sales and total assets and this ratio is an indication whether total assets have been properly used or not and hence proves the management efficiency. Higher the ratio larger is the return but a symptom of overtrading.

 

CCR:        The Conversion Cost ratio is the Labour cost and Manufacturing Expenses to Net Sales of a company. This ratio signifies the conversion cost of raw material to the finished product to sales.

Posted Date: 7/26/2012 4:01:59 AM | Location : United States







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