Skip to main content

Ratio Analysis Part-2

Activity Ratios

Activity Ratios measures the speed of various accounts / assets converted into sale or cash. the most important ratio use to measure the Activity Ratio is Inventory Turnover Ratio, it measures the liquidity of the firm. It is calculated as:

Inventory Turnover = Cost of good sold / Inventory
Note: Inventory turnover ratios should be compared with the result of same industry.  for example, Cloth Industry should be compared with Cloth industry and Glass industry should be compared with Glass industry.


The Average Collection Period

The average collection period, or average age of accounts receivable, is useful in evaluating credit and collection policies. It is calculated by dividing the average daily sales into the accounts receivable balance:
Average collection period = Accounts receivable / Average sales per day
Average sales per day = Annual Sales / 360
The average collection period for ABC Company in 2003 is
                                                                                              =     $503,000 / 8539 = 58.9 days.
On the average, it takes the firm 58.9 days to collect an account receivable. The average collection period is meaningful only in relation to the firm’s credit terms. If extends 30-day credit terms to customers, an average collection period of 58.9 days may indicate a poorly managed credit or
collection department, or both. It is also possible that the lengthened collection period resulted from an intentional relaxation of credit-term enforcement in response to competitive pressures. If the firm had extended 60-day credit terms, the 58.9-day average collection period would be quite acceptable. Clearly, additional information is needed to evaluate the effectiveness of the firm’s credit and
collection policies.

Average Payment Period

The average payment period, or average age of accounts payable, is calculated in the same manner as the average collection period:
Average payment period = Accounts payable / Average purchases per day
Average Purchase per day = Annual Purchase / 360
Average payment period calculation is difficult to calculate because annual purchase is not mentioned in financial statements. Annual Purchase is estimated through given percent age of Cost of Goods Sold. Assume
Cost of Goods Sold is  $2088,000  Annual Purchase is 70% of cost of good sold and Accounts payable is $382,000 then Average Collection period is

$382,000 / 0.70 x 2088,000 / 360 = 94.1 days

Total Asset Turnover





The total asset turnover indicates the efficiency with which the firm uses its assets
to generate sales. Total asset turnover is calculated as follows:
                      Total asset turnover   =  Sales / Total Assets
The higher a firm’s total asset turnover, the more efficiently its assets have been used. This measure is probably of greatest interest to management, because it indicates whether the firm’s operations have been financially efficient.

Comments

Post a Comment

Popular posts from this blog

What is Knowledge and kind of knowledge

What is Knowledge?  Knowledge is a mix of texts, values, numbers and contextual information and expert opinions that provide a framework for evaluating and incorporating new experiences and information. Knowledge organized and applied in the mind of knowers. It stored in individual minds Knowledge is a unique word and made up of two key factors i.e. (data + information). Data is un-arranged   symbol, text and values. which have no meaning itself alone, and Information is a raw material about facts, figures and values and when we arrange these facts and figures and information in a sequence and give meanings itself, it become knowledge. 
Post a Comment
Read more

Management Skills, Knowledge and Performance

Management Skills, Knowledge and Performance Management Knowledge : Managers need a knowledge base. This knowledge base provides a context for the manager’s activities, include information about an industry and its technology, company policies / procedures, and practices and actions, company goals and plans, company culture, the personalities of organization members, and important suppliers and customers. Management Skills : Managers need three types of key skills to perform the duties and activities in the organization. These skills are:
Post a Comment
Read more

Human Resource Development: Nurturing the Potential of an Organization.

  Introduction Human Resource Development (HRD) is a crucial aspect of modern organizations, emphasizing the growth, enhancement, and harnessing of their human capital . In today's competitive business landscape, organizations recognize that their most valuable asset is their workforce. HRD plays a pivotal role in ensuring that employees are equipped with the necessary skills, knowledge, and abilities to meet organizational objectives. This article explores the significance of HRD, its key components, and its impact on organizational success. Understanding Human Resource Development HRD is a holistic approach that encompasses various processes, practices, and strategies aimed at improving an organization's human capital. It is not limited to traditional training and development programs but extends to a broader range of activities designed to maximize the potential of employees. HRD focuses on both personal and professional growth, emphasizing continuous learning and adaptatio...
Post a Comment
Read more