Activity (or performance) ratios

There are a number of ratios which examine whether or not a business is using its resources efficiently. These include: administration to sales, asset turnover, stock turnover, and debt collection period.

Administration expenses to sales. Another way in which a business can monitor how well it is controlling its costs is by calculating the ratio of administration or overhead expenses to sales revenue or turnover. The larger the percentage of sales revenues used to pay for administration expenses, the worse the cost control performance of the firm.

Admin to Sales (%) = Admin Expenses x 100 / Sales Revenue

Asset turnover. Since the net assets of a business represent the value of the capital invested in it, it is useful to see how many times a business can generate sales in a year equal to the value of its capital or net assets. Asset turnover is a measure of the number of times that net assets are ‘turned over’ in sales in a year. This is another means of measuring the productivity of a business.

Asset Turnover = Turnover / Value of Net Assets

The stock turnover ratio measures the number of times in a year that a business sells the value of its stocks. It is a measure of business activity. The faster the rate of sales, the more times stocks will need to be replaced. If sales are poor, stocks will build up, indicated by low and falling ratio, and production will have to be cut.

Stock Turnover = Turnover / Value of Stocks

Generally, the higher the rate of stock turnover, the better the sales performance of the firm. What is an acceptable level of stock turnover will vary with the type of business. For example, a high-quality jeweller may only replace his or her stock of expensive rings and necklaces once each year, whilst a bakery would expect to replace its stock of fresh bread every day, giving a ratio of 365, and ratios of around 6 – 7 are probably acceptable for a car dealer.

Debtor collection period. It is possible to measure how well a firm is controlling the giving of credit to its customers by calculating the average amount of time taken by debtors to pay their invoices. Most firms give credit to their trade customers. The credit period will vary by the type of the firm. Typically, firms will give trade customers up to 60 days to pay invoices for goods or services delivered. If debtors are taking longer than this to pay, it indicates that the firm may have given credit unwisely and could be left with bad debts. However, some large firms may give credit for 90 days, while some small firms may struggle if their debts are not repaid within 30 days.

Because it is assumed that debtors will pay their invoices in the near future, sales on credit are treated as a current asset in the balance sheet. However, the larger the proportion of sales accounted for by credit sales, the more serious the consequences for the business if some of the debtors fail to pay.

Businesses can calculate the average number of days it takes for debtors to settle their debts. To do this, it is first necessary to work out the figure for an average day’s sales, by dividing total sales revenue by 365 days in a year. The next step is to calculate how many average days’ sales is represented by the debtors figure:

Debt Collection Period (Days) = Debtors / Average Daily Sales

= Debtors / Turnover / 365

For example, a firm may have average daily sales of 300 pounds and total credit sales during a year of 6,000 pounds. This means that the debtors figure represents on average 20 days of sales revenues (i.e. 6,000/300). That is, debtors take on average 20 days to settle invoices. Or, to look at it another way, it would take 20 days of sales to cover the credit sales to debtors if they should all fail to pay up within an agreed period.

Long delays in receiving payments from debtors can create cashflow problems for a business. Businesses will, therefore, normally operate a system of credit control, using an aged debtors list. This lists the names and the ‘ages’ of the debts of all the firm’s debtors. The business can then concentrate on collecting the oldest, or longest- outstanding, debts. Those debts that cannot be recovered after written warnings and even legal action are written off as bad debts.

Дата добавления: 2015-12-08