Activity Ratios
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Identify and explain two situations where an organization might have increasing activity rations but declining profitability.
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Solution Summary
The impact of increased activity ratios on sales and on profitability.
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First of all I will go on the basis that we are really talking about financial ratios versus rations. Given that assumption, the two most logical activity ratios to consider would be Accounts Receivable turnover and/or collection period, and Inventory turnover period. Both of these ratios are reliant on sales activity.
For example, if sales increase, then it is logical to determine that inventory turnover will increase as well --- if we sell more stuff we will need to have more inventory on hand to sell in order to meet market demand. Again, if sales increase and we are selling our products with credit terms, then it is logical to assume that accounts receivable will also increase, and coincidentally, will the ability of the firm to collect these accounts receivable in a timely manner.
Now let's digress for a minute and understand the role of inventory and accounts receivable in the process. Both are current assets, meaning that the firm will use them constantly over the normal operational cycle in order to gain cash flow; other wise known as profitability. A company will hold assets for two reasons only:
first is their ability to generate sales --- in this case both of these asset classes aid in generating ...
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