Interpretation of Activity Ratios

Activity Ratio:

An activity ratio is one of several accounting ratios that measure how quickly a company can
convert certain of its assets into cash, or revenue. The information used to calculate an activity
ratio is found on a company’s balance sheet or income statement. An activity ratio, along with
other accounting ratios, is used in fundamental analysis to determine the relative strength of a
company compared to its competitors.

The activity ratios include

 Inventory Turnover Ratio

 Asset Turnover Ratio
 Average Collection Period
 Average Payment Period
 Operating Cycle
 Cash Conversion Cycle

Years Involved:

Current year 2011

Base year 2010

Items Involved:

Cost of Sales Cost of Goods Sold

Opening and Closing Inventory

Sales

Total Assets

Gross Receivables

Credit Sales

Trade Creditors

Purchases
 Analysis Table:
Favorable/ Percentage
Ratio 2011 2010 Unfavorable Reason of Change of Change

Inventory Increase in
8.89 8.63 Favorable Cost of goods sold 33.41%
Turnover
Ratio

Asset Increase in
Turnover 2.62 2.13 Favorable Sales 34.82%
Assets 9.78%
Ratio

Average Decrease in
35 days 54 days Favorable Gross receivables -13.44%
Collection
Increase in
Period Credit sales 34.82%

Average Decrease in
6 days 28 days Favorable Trade creditors -71.15%
Payment
Increase in
Period Purchases 33.41%

Operating
76 days 96 days Favorable
Cycle

Cash
Conversion 70 days 68 days Unfavorable
Cycle
Interpretation:
Activity analysis has shown that National refineries limited has utilized its assets efficiently in
generating cash or sales this year because most of the indicators in activity ratio are showing
good or favorable results for the current year as compared to base year.

The trend in turnover ratios of company is positive as inventory turnover ratio has increased as
compared to last year that gives the indication that management is now managing the inventory
efficiently and it is not piling up the inventory for more days and has average inventory in
control. The asset turnover ratio is once again proving the efficient use of resources by the
management as compared to base year because the company is now producing more inventories
by utilizing its assets and in turn increasing the profits of the company. This also shows that if
the company has increased its assets, it has used them in a better way and has taken full
advantage of this investment and turned it into a profitable venture. The collection system of the
company is also favorable for the company. The company is not only getting its receivables early
but faster than the base year as well . So company can manage its cash in better way now and can
use it in some useful project for longer times than before. This positive trend in collection system
also highlights strict collection policy of NRL this year that it has adopted a more organized and
controlled method of receiving its money from customers and not giving them any unneeded
extension in time to get the collection from them. The payment period suggests that the company
has maintained very good relations with its suppliers and they are very supportive with company
and have confidence that NRL will pay its payment in specified time period, but in spite of all
these things company has paid its creditors earlier than base year which is a very good sign for
the company. The favorable results of company have continued in operating cycle and cash
conversion cycle as well. The operating cycle of company has shortened this year as compared to
base year giving the company extra days to produce and sell more inventory than base year.
Means the company can carry on more operations in similar span of one year i.e. 365 days as
compared to base year and can increase its profits in turn. But cash conversion cycle has
increased by a few margin which the company will have to improve.

These favorable results of activity ratio are going to help NRL in long run because all these
results are indication of good ability of company to produce sales and cash by utilizing its assets
which is very attractive feature for the investors and they will want to invest in this company by
seeing its current position. This will increase its current market value and reputation in turn.
Moreover the suppliers of company will want to build long term relations with company as it is
trying to paying them before the specified time and this long term relation will increase the value
of company as compared to its competitors who can face problems in getting good quality raw
material. The company will also be able to invest in profitable projects as it is managing its
receivables and payments very efficiently and it can have extra funds to invest in some other
places and get profit in return. This can also reduce the liabilities of company as it will be able to
pay all its expenses itself. So the company can enjoy these benefits for long time and can
increase its good will if it continues to show constant or good results in future as well.