How to Calculate a Financial Activity Ratio
Original post by Bryan Keythman of Demand Media
A financial activity ratio measures a company's ability to use its assets efficiently in its business. A company's assets are its resources with which it generates revenues and profits. Using assets efficiently is important for a company's success. You can calculate a financial activity ratio, such as inventory turnover and asset turnover, using information from a company's financial statements. A higher ratio means a company is using its assets efficiently, while lower ratios indicate a company's use of its assets may be negatively affecting its business.
Find a company's balance sheet and income statement in its annual report. You can obtain this from the "investor relations" section of its website, or in the company's annual report. You can also find this through the Security and Exchange Commission's EDGAR database.
Find the amount of the company's sales and the amount of its cost of goods sold on its income statement. For example, assume the company has $100,000 in sales and $40,000 in cost of goods sold.
Find the amount of the company's total assets and the amount of its inventory on its balance sheet. In this example, assume the company has $50,000 in total assets and $10,000 in inventory.
Divide the company's cost of goods sold by its inventory to calculate its inventory turnover, which measures the number of times the company completes the cycle of making inventory and selling it during an accounting period. In this example, divide $40,000 in cost of goods sold by $10,000 in inventory to get an inventory turnover of 4. This means the company made -- or purchased -- and sold its entire inventory four times during the year.
Divide the company's sales by its total assets to calculate its total asset turnover, which measures how much sales revenue the company generated for every dollar of assets it owns. In this example, divide $100,000 by $50,000 to get a total asset turnover of two. This means the company generated sales revenue equal to twice the amount of assets it owns.
Tips & Warnings
- Compare a company's activity ratios with those of its competitors in its industry to determine how efficiently it uses its assets compared to its peers. The companies with the highest financial activity ratios may have a competitive advantage.
- James Madison University; Financial Ratio Analysis; Pamela Peterson Drake
- AccountingCoach; Multiple-Step Income Statement; Harold Averkamp
- AccountingCoach; Sample Balance Sheet; Harold Averkamp
About the Author
Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.