Turnover Ratios/Activity Ratios

Activity ratios are classed as Turnover ratios. These ratios tell how active the firm is in selling stocks, collecting money from debtors, and paying to creditors. They are given below.

It is also called Stock turnover ratio. It indicates the number of times the average stock is being sold during a given accounting period. The higher the ratio, the better the performance of the firm in selling its stock. It is the rate at which inventories are converted into sales and then to cash.

Inventory Turnover Ratio =
Cost of goods sold / Average Stock

Cost of goods sold = Opening stock + Purchases + Manufacturing expenses – Closing stock (or) = Sales – Gross profit

Average stock =
(Opening stock + Closing stock) / 2

Note: 1. When cost of goods sold is not given, sales amount should be taken into account.
2. When opening stock is not given, closing stock is considered as ‘average stock’.

Example 1:

Inventory Holding Period =
365 days / Inventory Turnover Ratio

A firm sold goods worth Rs. 500000 and its gross profit is 20% of the sales value. The inventory at the beginning of the year was Rs. 16000 and at the end of the year was 14000. Compute inventory turnover ratio and also the inventory holding period.

Inventory Turnover Ratio =
Cost of goods sold / Average Stock

Cost of goods sold = Sales – Gross profit = 500000 – (500000 x 20%) = 400000

Average stock =
(Opening stock + Closing stock) / 2
= (16000 + 14000) / 2 = 15000

Inventory Holding Period =
365 days / Inventory Turnover Ratio
= 365 / 26.66 = 14 days

It reveals the number of times the average debtors are collected during a given accounting period. The firms usually prepare the aged list of debtors showing the details of when to collect and how much to collect from debtors. The higher the ratio, the better the performance of the firm in collecting money from debtors.

Debtors Turnover Ratio =
Net Credit Sales / Average Debtors

Net Credit Sales = Credit sales – Returns

Note: 1. When credit sales are not given, total sales are taken.
2. If opening debtors are not given, closing debtors should be considered as average debtors.

Example:

Debt Collection Period =
365 days / Debtors Turnover Ratio

A firm’s sales during the year were Rs. 400000 of which 60% were credit sales. The balance of debtors at the beginning and end of the year was 25000 and 15000 respectively. Calculate debtors turnover ratio of the firm. Also find out the debt collection period.

Debtors Turnover Ratio =
Net Credit Sales / Average Debtors
= 240000 / 20000 = 12 times

Net Credit Sales = Sales x 60/100 = 400000 x 60/100 = 240000

Average debtors =
(Opening debtors + Closing debtors) / 2
= (25000 + 15000) / 2 = 20000

Debt Collection Period =
365 days / Debtors Turnover Ratio
= 365 / 12 = 30.41 days

It reveals the number of times the average creditors are paid during a given accounting period. The firms usually prepare the aged list of creditors showing the details of when to pay and how much to pay to its creditors. It shows how promptly the firm is in a position to pay its creditors.

Creditors Turnover Ratio =
Net Credit Purchases / Average Creditors

Net Credit Purchases = Credit Purchases – Returns

Note: 1. When credit purchases are not given, total purchases are taken.
2. If opening creditors are not given, closing creditors should be considered as average creditors.

Example:

Creditors Payment Period =
365 days / Creditors Turnover Ratio

A firm’s purchases during the year were Rs. 400000 of which 50% were credit purchases. The balance of creditors at the beginning and end of the year was 30000 and 10000 respectively. Calculate creditors turnover ratio of the firm. Also find out creditors payment period.

Creditors Turnover Ratio =
Net Credit Purchases / Average Creditors
= 200000 / 20000 = 10 times

Net Credit Purchases = Purchases x 50/100 = 400000 x 50/100 = 200000

Average creditors =
(Opening creditors + Closing creditors) / 2
= (30000 + 10000) / 2 = 20000

Creditors Payment Period =
365 days / Creditors Turnover Ratio
= 365 / 10 = 36.5 days