FINANCIAL

REPORTING AND
ANALYSIS
Lecture: 11
Lecturer: HAROON IQBAL

ACTIVITY RATIOS
Activity Ratios also known as efficiency or turn

over ratios, measure how effectively the firm

is using its assets. Some aspects of activity
analysis are closely related to liquidity
analysis. Our focus is to attention on how
effectively the firm is managing two specific
asset groups receivables and inventories- and
its total assets in general.

Liquidity of inventory
To help determined how effectively the firm is managing

inventory (and also to gain an indication of the liquidity

of inventory) we compute the inventory turn over ratio.
This ratio, like other ratios, must be judged in relation to
ratios of similar firms, the industry average or both
Generally the higher the inventory turn-over , the more
efficient the inventory management of the firm and the
fresher more liquid, the inventory and vice versa. It
shows how quickly inventory is sold and is determined
by Inventory Turnover Ratio (ITO). It is the number
of times the company sells (turns over) it inventory
during the year.
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Inventory Turnover Ratio (ITO) =

Cost of good sold for the year/Average

inventory during the year

The higher the rate, the more quickly the
company sells its inventory. However, companies
selling high markup items e.g. Jewelry Stores, F16 can operate successfully with much lower ITO.
Days required to sell inventory: i.e.
Converting inventory into Receivables =
365 or 300/ITO
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Liquidity of
Receivables
It shows have quickly Accounts Receivables

are collected i.e. converted into cash. It is

determined by Receivable Turnover Ratio
(RTO). It is number of times Receivables are
converted into cash during the year.
= net sale for the year /Average Receivables during the
year
Ideally RTO = net credit sales/ Monthly average of
Receivables