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Today, we're diving into the world of fundamental analysis and exploring a crucial set of financial ratios that help us understand a company's efficiency in utilizing its resources to achieve the highest possible return. These are Activity Ratios.
Activity ratios are like a car's speed indicator. They help us understand inventory turnover rate, collection speed for outstanding debts, and how efficiently the company manages its current assets. By using simple equations based on data from the company's financial statements, you can calculate activity ratios and understand the company's ability to convert its resources into revenue as quickly as possible.
Let's see a real-life example to clarify:
Company (A) Example:
Item | Amount (Egyptian Pounds) |
Total Sales | 15,000,000 |
Total Current Assets | 10,000,000 |
Calculating Inventory Turnover Ratio (Sales to Current Assets Ratio):
Inventory Turnover Ratio = Total Sales / Total Current Assets
Inventory Turnover Ratio = 15,000,000 / 10,000,000 = 1.5 times per yearNote: You can easily calculate activity ratios using Excel by entering the data and applying the formulas.
When can we use activity ratios?
Before Investing: To understand the company's efficiency in managing its assets and generating sales.
Comparing Companies: You can compare companies in the same industry using activity ratios.
Monitoring Company Performance: Helps track the company's ability to convert inventory into revenue quickly.
What do activity ratios tell us?
They tell us about the company's efficiency in managing its current assets and achieving the best possible return. For example, a high inventory turnover ratio might indicate that the company sells its inventory quickly and recovers its cash, which is a positive sign.
Are there any limitations?
Activity ratios alone might not be sufficient for a comprehensive assessment of the company. We need to analyze them along with other financial data like profitability ratios and market indicators to get a clearer picture of the company's overall management efficiency.
Conclusion:
Activity ratios are a powerful analysis tool that helps investors and financial analysts assess a company's ability to achieve sales and utilize its resources efficiently. Understanding activity ratios is like understanding your car - you know how to reach your financial goals in the fastest time!
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