Performance or activity ratios judge how well the facilities at the disposal of the concern are being used. The ratios are usually calculated on the basis of cost of sales. The ratios are also known as turnover ratios as they express the rapidity with which a unit of capital invested in fixed assets, stock, etc. produces sales.
The following are the important turnover or performance ratios:—
Accounts Receivable = Trade Debtors + Bills Receivable from Customers
Trade debtors and bills receivable are taken at gross values. It means that for purposes of calculation of this ratio provision for bad debts and provision for discount on debtors are not deducted fi’om trade debtors and bills receivable.
When the information regarding credit sales and opening and closing balances of accounts receivable is not available, debtors turnover ratio may be calculated by dividing the total sales by the balance of accounts receivable as known.
Allowing credit to customers is one of methods of sales promotion. A liberal credit policy increases sales but results in tying up funds in the form of accounts receivable. If trade debtors are collected as scheduled, the firm is able to meet its short-term obligations comfortably. Thus, quality of trade debtors is important for sound liquidity position of the firm.
Thus, a good debtors turnover ratio is important. Higher the value of debtors turnover ratio, the better it is as it shows efficient collection of trade debtors. There is no standard debtors turnover ratio. What a good debtors turnover ratio is will depend upon the nature of the business.
The ratio of a firm should be compared with the ratio of other firms doing the same or similar business. Trend of the ratio in the firm should be studied to judge the efficiency or otherwise of the collection department.
Debtors Ratio or Debt Collection Period: It may be calculated for the same purpose for which Debtors Turnover Ratio is calculated.
The formula for the calculation of Debt Collection Period is as follows:-
Debt Collection Period shows the number of days’ sales that remain uncollected on the average. On comparison with the official credit period allowed by the firm, it would show whether debts are being collected on time or not.
If net credit sales for a year total Rs 73 lakh or Rs 20,000 per day and the accounts receivable total Rs 10 lakh, the debt collection period is 50 days. If the firm allows 30 days’ credit to its customers, debt collection period of 50 days will indicate slackness in collection.
To ascertain average daily credit sales accurately net credit sales for the year may be divided by the working days in the year. Hence some authors divide the yearly net credit sales by 300, taking 300 to be the number of working days. However, the customary figure is 365.
(vi) Creditors Turnover Ratio: It is also called Payable Turnover Ratio or Creditors Velocity. It shows the relationship between credit purchases and accounts payable.
Its formula is as follows:
Accounts Payable = Trade Creditors + Bills Payable accepted in favour of Suppliers.
Trade Creditors are taken at gross values. It means that for purposes of calculation of this ratio, reserve for discount on creditors, if any, is not deducted from trade creditors. When the information regarding credit purchases and opening and closing balances of accounts payable is not available, creditors turnover ratio may be calculated by dividing the total purchases by the balance of accounts payable as known.
Creditors Turnover Ratio will depend on the period of credit allowed by the suppliers and the firm’s ability to meet its liability in respect of accounts payable on time. Thus this ratio of the firm should be compared with the ratio of other firms doing the same or similar business.
Trend of the ratio in the firm should also be studied to determine the soundness of the policy followed by the firm in the matter of payment to suppliers.
Creditors Ratio or Average Payment Period:
May be calculated for the same purpose for which Creditors Turnover Ratio is calculated.
The formula for the calculation of Average Payment Period is as follows:-
Average Payment Period shows the number of days’ purchases that remain unpaid on the average. In other words, it shows the average number of days taken by the firm to pay to its suppliers of goods. On comparison with the credit period allowed by the suppliers, it will show whether the firm has been paying to its suppliers on time or not.
A low ratio may mean sound liquidity position of the firm with the result that the firm is able to take advantage of cash discounts allowed by the supplier. A higher ratio may imply less discount facilities availed or higher prices paid for the goods. A comparison of the ratio with the ratio of different other firms in the same industry and study of the trend of this ratio in the firm itself is very important.
(vii) Raw Materials Stock Turnover Ratio indicates whether stock of raw materials is too much, adequate or inadequate.
It is calculated as:
The figure will indicate the number of months’ consumption that the actual stock is equal to. The figure compared with the average delivery period will indicate over-stocking or under-stocking. Suppose, the stock of materials at the end of the year is Rs 3,00,000 whereas the consumption during the year was Rs 9,60,000 or Rs 80,000 per month.
Then the firm has stock of raw materials equal to consumption for 3.75 months. There is over-stocking if the stock can be acquired on reasonable prices, say, in six or seven weeks; but if the supply of material is seasonal and the next season is to start after, say, six months, the present stock is not adequate.