Activity Ratio

Visit us on www.camanojgupta.com      

i.        Inventory Turnover Ratio: This ratio indicates that how much fast the inventory is converted into sales so that any blockage of funds in inventory could be checked and liquidity in the system may be maintained. It is calculated as follows:

                Inventory Turnover Ratio =       Cost of Sales

                                                 Average Inventory

Average Inventory = Opening Inventory + Closing Inventory

                                                      2

Cost of sales =  Raw Material Consumed + Direct Expenses (Direct Labour, Manufacturing Exp., Depreciation, Power & Fuel etc) + Opening Stock in Process- Closing Stock in process + Opening Stock of finished stock – Closing stock of finished stock

The higher ratio indicates that the enterprise as able to achieve higher turnover with low level of inventory thereby reducing the chances of inventory hold ups or carrying over of obsolete inventory. The decreasing trend shows the sluggishness’ in demand of the product manufactured/traded by the concern with large carryover stocks demanding more investments with slow movements. It may also mean carryover of dead inventory.

     ii.         Creditors Ratio: This ratio indicates the credit period available to the concern for its purchase policy and payment period to the creditors. It is calculated as follows:

Creditors Ratio (in days) = Bills Payable + Sundry Creditors X 365

                                               Total Credit Purchase

 It indicates the reputation of the concern to get the material on credit; but it also shows sometimes the inability of the concern to pay its creditors promptly and timely which could be taken as adverse factor.

    iii.        Debtors Ratio: This ratio indicates the credit period given to its customers and the recovery of credit sales. It is calculated as follows:

Debtors Ratio (in days) = Bills Receivables + Sundry Debtors X 365

                                      Total Credit Sales

Longer period in realization of sales proceeds shows the incapacity of the concern to realize its dues on time. Further the increasing trend in this ratio indicates the slowness’ in the demand of the product of the company or has ended with some bad debts which can not be realized timely.

A small creditor’s ratio with a higher debtor’s ratio indicates that the concern is prompt to pay its dues but slow in recovery from customers i.e. longer credit cycle. This may be due to adverse market condition for the product and means larger investment for financing its sales.