Activity Ratios:

Activity ratios indicate how efficiently a firm uses and manages its resources (assets), including cash, accounts receivable, salaries, inventory, property, plant, and equipment.

Higher ratios may signal efficient use of those assets; while

Lower ratios may signal inefficient use of those assets.

Activity ratios provide an indication of how efficiently a firm runs its operations. For example, all other factors being equal, a firm that keeps a very modest amount of inventory is usually in better shape than a firm that has to keep (store, manage, warehouse, insure, and so forth) a large quantity of inventory.  Some activity ratios are operational as opposed to financial. One such activity ratio would be revenue per employee.

Revenue per Employee (FTE)

Obviously, the more revenue we produce per employee the more efficient we are using the resources (in this case people resources) that we have.

Revenue per customer

This is one that we love. Obviously, you need to have a consistent definition of what a customer is (not just a name in your database but rather someone you continue to do business with). The reason I like this one so much is that we can review this number with our sales team and create very specific future goals.

Example

Our average Quarterly Pest customer yields us $500 per year. Let’s increase that by 10% to $550 per customer.  This is very easily measured.

Collection Period / Days or Days sales in A/R

This ratio tells us how efficient we are at collecting our money or holding our customers to our credit terms.

Example

A company producing $365K in annual sales, which translates into $1k per day, that grants its customers 30-day terms should have $30K in A/R

Be careful that when using this ratio – Make sure that all Prepaids / Customer Deposits are backed out of you’re A/R number so that it is a true A/R number.

Asset Turnover

Generally speaking, the higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating higher revenue per dollar of asset. This ratio can vary widely from one industry to the next.  While this is a very widely used KPI in the world of finance, it works best in industries where there is a heavy investment in assets. Most firms in our industry utilize labor to a much higher degree than fixed assets and therefore we don’t put as much emphasis on this ratio as we do some of the others – again this is just another tool in the financial tool chest.

Inventory Ratio

Inventory turnover is a ratio showing how many times a company’s inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or “inventory turnover days.” A low inventory ratio is usually a bad sign as inventory may be over ordered or sales may not be as robust.

BIG CAVEAT:  Many times, at year end for both tax reasons and the fact that many distributers give great year end incentives, a lot of firms purchase large amounts of inventory which will drive the inventory account up in a big way – So carefully consider this abnormality when making comparisons.

Profit per employee

Again, this is not straight off the financials (as the financials don’t note FTEs).  However, this is an especially useful ratio to look at. Many times, in the heat of battle we start adding employees without a proper plan or the real time info to determine if it’s a good idea. This ratio helps to determine if you are making an acceptable profit for each employee. If profit per employee is being bench-marked, we can make decisions about human resources and determine if we can afford an increased headcount.

Payable period days

Like days of sales in A/R. This data point measures a firm’s payment history letting you know if you are meeting your obligations in a timely manner. If your vendors give 30-day terms and you are paying in 25 days you are able to meet your obligations within terms. If you pay in 35 days than you are not meeting your obligations in a timely manner. If you can consistently pay your vendors quickly, many vendors may offer a discount. Terms such as 2/10 net 30 can save a business significant amounts of cash. These terms would be to take a 2% discount if you pay within 10 days or else pay in full by 30 days.

Where:

COGS = Cost of Goods Sold or direct costs,
A/P = Accounts Payable

Below table is for the median