[MUSIC] Last time, we saw a number of profitability ratios. In this video, we will look at some of the common activity ratios, like total asset turnover. Fixed asset turnover, working capital turnover, days receivables outstanding, days inventory held, days payable outstanding, and cash conversion cycle. Activity ratios measure a company's ability to convert assets and liabilities into cash or sales. The faster it is able to do this, the more efficiently the company is run. The first activity ratio is the total asset turnover. It measures how efficiently a company uses all its assets to generate revenues. It is defined as revenues divided by average total assets. Amazon's revenues in 2015 were $107.01 billion and its average total assets were $59.97 billion. This gives its total asset turnover to be 1.78. Every dollar in total assets generates $1.78 in revenues. This ratio has worsened for Amazon over the last 4 years as it was over took in 2012. However, the drop in total asset turnover may be indicative of Amazon investing in more assets with an eye towards future growth. These long-term investments and assets may reduce total asset turnover in the short-term. The average total assets have actually doubled over the last four years, so the decrease in total asset turnover may not be indicative of Amazon's worsening efficiency. The next activity ratio is the fixed asset turnover, this is similar to the total asset turnover, but specifically measures how efficiently a company uses its fixed assets to generate revenues. Amazon's fixed assets include investments in plant property and equipment, PP and E, goodwill, and other intangible assets. It's average fixed assets in 2015 were $22.94 billion. At revenues of $107.01 billion by $22.94 billion gives us a fixed asset turnover of 4.66. For every $1 invested in fixed assets, Amazon generates $4.66 in revenue. Similar to total fixed turnover, Amazon's fixed asset turnover has decreased over the last four years. This, again, is not necessarily bad, as its fixed assets have almost tripled in four years. Amazon may have invested more in fixed assets with the focus on future growth. The remaining activity ratios are related to a company's current assets and liabilities. The first of which is working capital turnover. It is defined as the ratio of revenues to average working capital. Working capital measures a company's operating liquidity. It tells us if the company has sufficient operations-related current assets to pay off its operations-related current liabilities. It is calculated as accounts receivables plus inventory minus accounts payables. Working capital turnover indicates a companies effectiveness in using its working capital. That is, does it generate enough revenues using its working capital? Amazons average working capital in 2015 was a -$3.14 billion. Given it's revenues of $107.01 billion in 2015, Amazon has a working capital turnover of -$34.08. A negative working capital turnover is quite meaningless other than saying that its current liabilities exceed its current assets. The working capital turnover is consistently negative over the last four years. So it is impossible to interpret whether Amazon has been efficiently using its working capital to generate revenues. Next, we look at the receivables turnover, and days receivables outstanding. Receivables turnover measures how soon sales will become cash. It is defined as revenues divided by average receivables. In 2015, Amazon had average receivables of $6.02 billion. Dividing its revenues of $107.01 billion by the average receivables gives us a receivables turnover of 17.78. This says that Amazon converts its revenue to cash 17.78 times a year. Dividing 365 by the receivables turnover gives us the days receivables outstanding of 20.53 days. That is, Amazon converts its revenues to cash every 20.53 days. Days receivables outstanding is also called days sales outstanding. Days receivables outstanding is increased marginally from 17.73 days in 2012. This may be indicative of some of Amazon's customers having financial difficulties and hence delayed their payments. It also could be that Amazon's credit department is doing a poor job of recovering amounts due to it. The next pad of activity that shows is also related to current assets, specifically inventory. Inventory turnover measures how soon a companies inventory is being sold. It is defined as the ratio of COGS, cost of goods sold, to average inventory. In 2015, Amazon had COGS of $17.65 billion and average inventories of $9.27 billion dividing cogs by average inventories gives us an inventory turnover of 7.73. This means that Amazon turns over its inventory 7.73 times a year. Dividing 365 by the inventory turnover gives us a days inventory held of 47.23 days. Amazon sells its inventory every 47.23 days. The days inventory held has also increased slightly over the last four years. This could be indicative of company losing some sales but nothing too dramatic. This is further supported by the fact that its inventory levels have doubled over the last four years. An alternate explanation could be that Amazon is planning a large sale and building up its inventory for this reason. Finally, we look at how quickly a company pays its suppliers. This is measured using payables turnover and days payable outstanding. Payables turnover is the ratio of a company's purchases to average accounts payable. Purchases are defined as the change in inventory over the year plus the COGS for the year. In 2015, Amazon's inventories increased by $1.94 billion. And its COGS were $71.65 billion. Adding the 2, Amazon's purchases in 2015 was $73.59 billion. Dividing this by its average accounts payable of $18.43 billion gives us payables turnover of 3.99. Dividing 365 by the payables turnover of 3.99 gives us days payables outstanding of 91.40. This says Amazon pays its suppliers 3.99 times a year or once every 91.4 days. The days payables outstanding has decreased marginally over the past four years. When this may mean that Amazon is paying its suppliers more quickly, it could also mean that either the suppliers are not extending credit to Amazon or that some of the credit terms offered by its suppliers are too good for Amazon to pass up. One last measure of a company's activity is the cash conversion cycle. It is calculated by adding days receivable outstanding and days inventory held and subtracting days payable outstanding. It measures how quickly our company can work it's current assets to cash. The lower the cash conversion cycle, the better job the company is doing in converting to cash. A negative number is even better as it denotes that the company does not pay for it's inventories. Until it has sold it's products or services. It means that the company is managing it's working capitol as efficiently as possible and has cash available for a number of other things. Amazon's days receivable outstanding is 20.53. It's days in inventory held is 47.23, and it's days payable outstanding is 91.40. Adding the first two and subtracting the third, gives Amazon's cash conversion cycle to be a -23.64 days. Like we discussed earlier in negative cash conversion cycle denotes that the company converted receivable and inventories to cash before it has to pay it's payables. However, Amazon's cash conversion cycle has increased of the last few years. And so, it indicates that it isn't doing as well as it has been. This wraps up our discussion on activity ratios. Next time we will discuss what solvency and liquidity ratios and the different types of these ratios. [MUSIC]
