Activity Ratios: Asset Turnover Ratio, Inventory Turnover in Excel

Activity ratios are essential metrics that reveal how efficiently a company utilises its assets to generate revenue and manage its inventory. They measure the effectiveness of a company’s operations and resource utilisation. In this chapter, we’ll explore two key activity ratios—Asset Turnover Ratio and Inventory Turnover Ratio—and how to calculate them in Excel.

What Are Activity Ratios?

Activity Ratios measure a company’s operational efficiency. They help assess how well a company uses its assets and manages inventory, impacting profitability and cash flow.

• Asset Turnover Ratio: Measures how efficiently a company uses its assets to generate revenue.
  
• Inventory Turnover Ratio: Indicates how effectively a company manages its inventory by showing how frequently inventory is sold and replaced over a period.
  

Asset Turnover Ratio

The Asset Turnover Ratio indicates how efficiently a company utilises its assets to generate sales. A higher ratio suggests better efficiency, as it implies that the company is generating more revenue per unit of assets.

Formula for Asset Turnover Ratio:

Asset Turnover Ratio = Net Sales / Average Total Assets

Where:

• Net Sales = Total sales or revenue generated by the company.
• Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Step-by-Step Guide: Calculating Asset Turnover Ratio in Excel

Step 1: Input Data

Suppose a company has:

• Net Sales = ₹15,00,000
• Beginning Total Assets = ₹8,00,000
• Ending Total Assets = ₹10,00,000

Step 2: Calculate Average Total Assets

In Excel, calculate the average total assets:

= (Beginning Total Assets + Ending Total Assets) / 2

For this example:

= (800000 + 1000000) / 2

Result: The Average Total Assets is ₹9,00,000.

Step 3: Apply the Asset Turnover Ratio Formula

Now, use the formula in Excel to calculate the Asset Turnover Ratio:

=Net Sales / Average Total Assets

For this example:

=1500000 / 900000

Result: The Asset Turnover Ratio is 1.67.

This means the company generates ₹1.67 in sales for every ₹1 of assets, indicating efficient asset utilisation.

Inventory Turnover Ratio

The Inventory Turnover Ratio measures how effectively a company manages its inventory. A higher ratio suggests strong sales or efficient inventory management, as it implies inventory is being sold and replaced frequently.

Formula for Inventory Turnover Ratio:

Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory

Where:

• COGS = Cost of goods sold during the period.
• Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Step-by-Step Guide: Calculating Inventory Turnover Ratio in Excel

Step 1: Input Data

Suppose a company has:

• COGS = ₹7,50,000
• Beginning Inventory = ₹2,00,000
• Ending Inventory = ₹2,50,000

Step 2: Calculate Average Inventory

In Excel, calculate the average inventory:

= (Beginning Inventory + Ending Inventory) / 2

For this example:

= (200000 + 250000) / 2

Result: The Average Inventory is ₹2,25,000.

Step 3: Apply the Inventory Turnover Ratio Formula

Now, use the formula in Excel to calculate the Inventory Turnover Ratio:

=COGS / Average Inventory

For this example:

=750000 / 225000

Result: The Inventory Turnover Ratio is 3.33.

This means the company’s inventory is sold and replaced approximately 3.33 times during the period, indicating efficient inventory management.

Why Use Activity Ratios?

• Operational Efficiency: These ratios help evaluate how well a company uses assets and manages inventory.
  
• Profitability Insight: High activity ratios are often linked to higher profitability and effective resource use.
  
• Investor Confidence: High efficiency often signals a strong business model, building investor confidence.
  

Key Takeaways:

• Asset Turnover Ratio indicates how effectively a company uses its assets to generate sales.
  
• Inventory Turnover Ratio reflects how efficiently inventory is managed.
  
• Excel automates these calculations, making it easy to analyse and track activity ratios over time.
  

Conclusion:

Calculating the Asset Turnover Ratio and Inventory Turnover Ratio provides valuable insights into a company’s operational efficiency and inventory management. Excel simplifies these calculations, allowing for quick and accurate analysis.

Next Chapter Preview: In the next chapter, we’ll cover Return on Equity (ROE) and Return on Assets (ROA) Calculation in Excel. These profitability ratios help assess how effectively a company is generating profits from its equity and assets. Stay tuned!