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How is business efficiency measured?

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An activity ratio measures the relationship between a firm’s level of operations, usually stated in terms of sales (turnover), and the assets needed to maintain the activity, it indicating the efficiency with which a firm uses its assets.  Average assets held during a period are used for comparison with the income statement items (e.g., sales or COGS).  The higher the activity ratio, the more a given level of sales can be maintained with relatively fewer assets.  Activity ratios include:

  • Receivables turnover – Measures the number of times receivables are collected during the period:

Net Sales/Average Accounts Receivable (or Trade Receivables)
Credit Sales/Average Accounts Receivable (or Trade Receivables)

  • Average collection period – A variant of the receivables turnover ratio that converts it into the number of days takes for a firm to collect its receivables:

365/Receivables Turnover

Accounts Payables/Net Sales

  • Inventory turnover – Measures the efficiency of a company in managing and selling its inventory:

COGS/Average Inventory
Net Sales ÷ Average Inventory

365/Inventory Turnover

Net Sales/Average PP&E

  • Total-asset turnover – Measures the sales volume a company generates relative to its total investment in assets:

Net Sales/Average Total Assets

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