Accounting: Accounting Ratios: Activity or Turnover Ratios and Stock/Inventory Turnover Ratio

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Activity Ratios are useful to measure the efficiency or effectiveness of the firm. This also indicates the speed at which assets are converted or turned over in sales. There are different types in Activity Ratios. Those are –

Stock/Inventory Turnover Ratio

It is the ratio between cost of goods sold and average inventory or stock.

Stock Turnover Ratio =

Cost of Goods Sold = Sales – Gross Profit (or)

Cost of Goods Sold = Opening stock + Purchases + Direct expenses – Closing Stock

Average Stock =

Inventory Conversion period =

Significance

The ratio signifies the number of times on an average the inventory or stock is disposed off during the period. The high ratio indicates efficiency and the low ratio indicates inefficiency of stock management.

Example: Annual sales Rs

Gross profit on sales

Opening stock Rs

Closing stock Rs

Calculate stock turnover ratio and inventory conversion period for 2006.

Assume 360 days in the year.

Solution: Stock Turnover Ratio =

Costs of goods sold = Sales – Gross profit

= Rs

Average Stock = =

= 40,000

Stock Turnover Ratio = = 8 times

Inventory Conversion period =

= = 45 days

Debtors Turnover Ratio

It is the ratio between net credit sales and average debtors.

Debtors Turnover Ratio =

Average Debtors =

Note: If opening debtors are not available then closing debtors and bills receivable are taken as average debtors.

Debt Collection Period

It measures an average period for which the credit sales remain

Unpaid and measures the quality of debtors. Quality of debtors means payment made by debtors within the permissible credit period.

Debt Collection period =

Significance

  • It indicates the speed at which debs are collected from debtors

  • Higher ratio indicates lesser debt collection period and it is preferable

  • Lower ratio indicates higher debt collection period and it is not preferable

Example: Find out (a) debtors turnover and (b) average collection period from the following information for one year ended 31st March 2006.

Annual credit sales Rs.500000

Debtors in the beginning Rs.80000

Debtors at the end Rs.100000

Debt to be taken for the year 360 days.

Solution:

Debtors Turnover Ratio =

Average Debtors =

=

= Rs. 90000

Debtors Turnover Ratio = = 5.56 times

Debt Collection period = = 65 days

Creditors Turnover Ratio

It is the ratio between net credit purchases and average Creditors.

Creditors Turnover Ratio =

Net purchases = Total purchases – Purchase returns

Net credit purchases = Net purchases – cash purchases

Average Creditors =

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