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Activity ratios / turnover Ratios (Ratio Analysis) with problem and solutions - YouTube
Channel: Management by Dr. Mitul Dhimar
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Hello everyone again
welcome to the video
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series of Ratio Analysis
I hope you’re all doing great
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So, friends, today will learn about
Activity Ratios or turnover ratios.
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We will start with the meaning,
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Like other different ratios these
ratios will have a meaning by its name.
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It’s activity ratios which will
tell us how active our business is.
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If we want to know how efficiently
a business is operating
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and how well a business is using its
different assets to generate cash,
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Activity ratios will provide us these answers.
Now, on what base we can check efficiency.
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On what bases we’ll say that
this business is efficient.
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The answer is sales.
Sales is the only proper
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base for checking efficiency.
So, the different ratios that
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we’ll find under this head will have
sales used directly or indirectly.
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So, different activity ratios we find
to check business’s efficiency are,
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Stock Turnover Ratio
Debtor’s Ratio & Debtor’s Turnover
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Creditor’s Ratio & Creditor’s Turnover
Fixed Assets turnover
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Current Assets turnover
Working Capital turnover
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The first ratio is Stock Turnover.
So, how we can check the efficiency of Stock?
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It is only by knowing how many times
our stock is being converted in Sales.
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If the stock is not becoming the sales than it
has ZERO efficiency, it is as good as scrap.
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So, this ratio will tell
us how fast Stock is sold.
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Now one thing to understand here that if
we are having a stock of raw material,
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it’s efficiency will be checked
on the basis of Consumption
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and if we are having a stock of finished goods,
then it’s efficiency will be
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checked on the basis of Sales.
So, if we try to make the formula,
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basic formula will be Sales divided by Stock.
Now, sometimes we will
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have opening and closing stock
so at that we have to take the average stock.
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If there is only one stock is given then
then there is no need to find average stock
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but if we have both than we
have to go with average stock.
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Now we have one more problem here is that
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we show stock at our cost price
but we show sales with profit.
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So numerator has profit but denominator
has no profit, it’s mismatch.
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So in this case, either we can to add profit
in stock or we can to remove profit from sales.
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So what we do, generally we remove profit from
sales so that becomes our Cost of goods sold.
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So, the main formula of our Stock Turnover will
be Cost of goods sold divided by Average stock.
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Now, to find Cost of goods sold
we will remove gross profit from sales
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so total Sales minus gross profit
that is our cost of Goods sold.
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Or we can have cost of goods
sold with another formula
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that is Opening stock plus Purchase plus
Purchase Expenses less Closing stock.
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And the formula of average stock is very simple,
it is Opening stock plus Closing
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stock divided by two.
Now lets do a practical problem.
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I have a income statement of Sneha ltd. here.
Total sales given is 20,00,000 rs.
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And gross profit is 15 lakh so our cost
of goods sold will be 5 lakh rurees.
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Ok. Opening stock is 1,00,000 and closing stock
is 96,000 and we put them in this formula,
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than total sales given is
20,00,000 gross profit is 15,00,000
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so our cogs is 5,00,000 and have 1,00,000 rs.
Of opening stock and 96000 for closing stock
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so our closing stock will be 98000
and to find stock turnover ratio
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we will use this formula cost of
goods sold that is rs. 5,00,000
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divided by average stock that is 98000
so our answer will be around 5.10 times
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so 5.10 times my average stock
is being converted into sales
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Now if we go for debtor’s ratio,
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then we have to think how we can
measure the efficiency of debtors.
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First thing is that when say debtors it means not
debtors only but debtors plus bills receivables.
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So how can we check the debtor’s
efficiency it can be checked on two basis.
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First thing to remember here is
Debtors are supposed to pay me cash.
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So first base will be how
quickly they are paying me.
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If they are taking too long
than I am getting cash late,
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which suggests low efficiency and if am
getting payment quickly than it’s good.
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I can use that cash in other operations.
So this will my be first base how quickly
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I am getting money form my debtors.
Now to find this I will use debtors ratio.
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So our formula will be closing
balance of accounts receivables
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that is debtors plus bills receivables divided
by net credit sales, net credit sales means
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total credit sales – sales returns
and into annual time.
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So we have to take annual time here if the time
is given days that it will be 365 or 360 days,
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in months it will be 12 months or if
in weeks than it will be 52 weeks.
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Now if I go for a practical example
I have balance sheet that has
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closing balance of debtors 2,60,000
and bills receivables 75,000
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in income statement sales is 20,00,000
total sales 20,00,000
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and credit and cash sales
are in ratio of 3 is to 2
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and if I check the additional
information 3rd additional
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information says take 365 days annually.
So, here in formula the closing balance
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of my debtors are 260000 + 75000 of br
divided by net credit sales 2000000 total sales
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and the ratio was 3:2 so 3 divided
by 5 into annually 365 days
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so this will be 335000 divided by 12000000net
credit sales into 365 so approximately 102 days
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so debtors are taking 102 days to making
me payment sorry for making me payment
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The second base to check debtor’s efficiency
is how many times I am getting paid by debtors.
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Obviously, if I am getting paid
less times than it’s less efficient
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and if I am getting paid more than my debtors
are generating more cash which is good.
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So to check this I will find ebtors
turnover just like stock turnover
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this is debtor’s turnover and formula is just like
stock turnover net credit sales divided by
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average account receivables.
This is debtor’s turnover so we
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have to take credit sales, net credit
sales and avg. accounts receivables
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to find that we have opening
balance of debtors and br
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plus closing balance of
debtor’s and br divided by 2.
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Now I have 12000000 rs for net
credit sales as we calculated above
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and to find average accounts receivables
I will need opening balance of debtors and br
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and closing balance of debtors
and br now we have already used
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closing balance of debtors
and br in above ratio that was 260000 and 75000
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divided by 2 and for opening balance
I have to check additional information here in
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additional information opening balance of debtors
and bills receivables
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is 2800000 and I lakh respectively.
Opening balance 2 lakh 80 thounds
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and 1 lakh ok so our average
accounts receivables will be 3 575000
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and if we put this amount in debtor’s
turnover formula 12 lakh divided by 357500
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and our answer will be 3.36 times
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Next is creditor’s ratio.
This ratio is just debtor’s ratio but in reverse
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mode because we are supposed to pay to creditors.
So, this ratio will check our efficiency in
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making payments to our creditors.
Of course, it will be checked
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on 2 bases just like debtors.
first how quickly we are paying?
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If we are paying late than it will
affect our reputation in market
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and if we are paying too early than we are not
using credit period enough and losing money early.
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So, we have to make payment just one or
two days before our final date of payment
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to achieve highest efficiency.
So, to find the days we are taking to
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make payment we will find creditor’s ratio
and formula will be closing balance of
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creditors and bills payables
divided by net credit purchase into annual time.
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So here in balance sheet I
have creditors of re 50000
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and bills payables of rs 60000
and if I check income statement
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for purchase total purchase given is 450000
and credit and cash purchase is in ratio of 7:3.
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So, here in formula it will be creditors
of rs. 50000 bills payables of rs 60000
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and divided by total purchase
450000 into 7 is to 10 into 365 days
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so it will be 110000 divided by 315000
into 365 that will be around 127 days
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And to find how many times
we are paying to creditors
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we will find creditor’s turnover.
Formula will be net credit purchase
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divided by average accounts payables.
And to find average accounts payable
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opening balance of creditors
and bp plus closing balance of creditors
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and bp divided by 2
so net credit purchase
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is 315000 divided by average accounts payables
so for that we have already used the closing
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balance of creditors and bills payables
that was rs. 50000 and 60000 divided by 2
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and for opening balance of
creditors and bills payables
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I will have to check additional information
here in additional information opening
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balance of creditors
and bills payables
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is 40000 and 50000 so 40000 and 50000
so our average accounts payables will be 100000
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so here it will 315000 divided by 100000
so creditor’s turnover will be 3.15 times
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And now we are moving on to last
three ratios under this head that are
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Fixed Assets turnover
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Current Assets turnover
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Working Capital turnover
If we want to know how
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well we’re using our fixed assets,
current assets and working capital to
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generate cash these 3 ratios will be helpful.
So the making of the formula is very easy.
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They all have sales in their
name so sales is in every formula
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so in fixed assets turnover we have to
divide with avg. net fixed assets so average
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means opening balance of fixed assets
plus closing balance divided by 2
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and net means after depreciation.
In currents by average current assets
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and in working capital with working capital
working capital is equal to current assets
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less current liabilities now I check
the balance sheet and income statement
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