# What is an activity relationship?

An activity ratio is one of several accounting ratios that measure how quickly a company can turn certain assets into cash or revenue. Three commonly evaluated activity ratios are the Asset Turnover Ratio, the Inventory Turnover Ratio, and the Accounts Receivable Turnover Ratio. An activity index, along with other accounting ratios, is used in fundamental analysis to determine a company's relative strength compared to its competitors. The information used to calculate an activity index is found on a company's balance sheet or income statement.

The asset turnover ratio indicates how quickly, on average, a company can turn an asset into cash. The asset turnover ratio is calculated by dividing sales by average total assets. If annual sales are \$1 million US dollars (USD) and average assets for the year are \$500,000, the asset turnover ratio is 2. This means that the company turns over its assets twice a year. A better asset turnover ratio is better, because it means the company is turning over its assets more often, therefore, it is turning assets into sales faster.

The inventory turnover ratio indicates how often the company turns its inventory into revenue. Again, a higher ratio is better because it indicates that the company is quickly moving product from its warehouse to stores and ultimately into the hands of consumers. Analysts can determine the inventory turnover ratio by dividing sales by average inventory.

A company's efficiency in collecting money owed by customers is measured by the accounts receivable turnover ratio, sometimes called the accounts receivable turnover ratio. To determine this ratio, analysts divide net sales on credit by average accounts receivable. A low rate could mean that the company is having trouble charging its customers. A company that does most or all of its business in cash will have a very high accounts receivable turnover rate.

As with all accounting ratios used in fundamental analysis, it is important to compare any activity index between companies in the same industry. Typically, some industries will have much lower ratios than others, so comparing companies across industries will typically yield irrelevant data. For example, an activity index for a manufacturing company will generally be much lower than the same activity index for a fast food company. For a comparison of an activity index between two or more companies to be useful, the companies must be in the same industry.

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