[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 it 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 generated $1.78 in revenues. This ratio has worsened for Amazon over the last four years, as it was over 2 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. And 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 PP and E, goodwill and other intangible assets. Its average fixed assets in 2015 were $22.94 billion. Dividing its 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 revenues. 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 a focus on future growth. The remaining activity ratios are all 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 turnover minus accounts payable. Working capital turnover indicates a company's effectiveness in using its working capital, that is, does it generate enough revenues using its working capital? Amazon's average working capital in 2015 was a negative $3.14 billion. Given its revenues of $107.01 billion in 2015, Amazon has a working capital turnover of negative 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 day's 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 revenues to cash 17.78 times a year. Dividing 365 by the receivables turnover gives us a days receivable outstanding of 20.53 days. That is, Amazon converts its revenues to cash every 20.53 days. Days receivable outstanding is also called days sales outstanding. Days receivable outstanding has increased marginally from 17.73 days in 2012. This may be indicative of some of Amazon's customers having financial difficulties and hence the delay in their payments. It could also be that Amazon's credit department is doing a poor job of recovering amounts due to it. The next pair of activity ratios are also related to current assets, specifically inventory. Inventory turnover measures how soon a company's inventory is being sold. It is defined as the ratio of COGS to average inventory. In 2015, Amazon had COGS of $71.65 billion, and average inventories of $9.27 billion. Dividing COGS by average inventory 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 also has 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 is 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 base 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 inventory increased by $1.94 billion, and its COGS was $71.65 billion. Adding the two, 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 payable 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 last 4 years. While this may mean that Amazon is paying its suppliers more quickly, it could also mean either 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 a company converts its 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 a company does not pay for its inventories until it has sold its products or services. It means that the company is managing its working capital as efficiently as possible, and has cash available for a number of other things all the time. Amazon's days receivables outstanding is 20.53, its days inventory held is 47.23, and its days payables outstanding is 91.40. Adding the first two and subtracting the third gives Amazon's cash conversion cycle to be a negative 23.64 days. Like we discussed earlier, a negative cash conversion cycle denotes that the company converts its receivable in inventories to cash before it has to pay its payables. However, Amazon's cash conversion cycle has increased over 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 are, and the different types of these ratios. [MUSIC]
