Financial statement ratio - activity ratios Flashcards
Activity ratios
Measure of efficiency of a firm’s assets:
- Receivables turnover
- Days sales outstanding (DSO)
- Receivables turnover / DSO:
- Inventory turnover
- A/P turnover
- Payables payment period (PPP)
- AP turnover and PPP
Receivables turnover
Revenue / Average accounts receivable
If you only need $50 in inventory to support $1,000 in COGS that means you carry very little inventory; can be advantageous because it means you do not need large amounts of cash for inventory requirements until a sale is actually made. Had you needed large inventory purchases prior to the sale, you would have had to tap other financing sources like debt.
Days sales outstanding (DSO)
Days in period / receivables turnover
Receivables turnover / DSO
Identical conceptually to inventory turnover – if you collect very fast from customers, you immediately get cash. If you had to wait a long time for customers to pay, cash that you need for other activities would have to come from somewhere else (like debt). Another way to express the relationship between A/R and sales is days sales outstanding (DSO) = (AR / Credit Sales) x days in period.
Inventory turnover
COGS / average inventory
A/P turnover
COGS / Average AP
Payables payment period (PPP)
Days in period / AP turnover
AP turnover and PPP
Measures how quickly a company pays its vendors. Generally longer credit terms provide a company with more flexibility. Imagine a scenario where you use your cash inflows from operations to fund your operating cash outflows. If the average DSO is 30 days but the average PPP is 15 days, that means that cash from customers takes longer to collect than the terms your vendors have provided you – and implies that you cannot rely on receivables alone to fund your short term credit terms – you’ll need to access other capital sources.
