Asset management ratios help to understand how effectively the business uses its assets to generate revenue. It’s an essential ratio for the business stakeholders to assess if management is actively using the assets.
As these ratios measure the efficiency of revenue generation, the same is the reason that these ratios are also called efficiency/turnover ratios. It’s important to note that these ratios only use revenue and assets as input in the calculation. So, it’s a comparative study to find some relation between the revenue and total assets of the business.
Purpose of calculating asset management ratios
The purpose of calculating the asset management ratio is to assess the business’s financial performance with perspective to the management of activities. The concept is simple if the business can effectively manage their assets, they are expected to present better financial performance.
So, potential investors not only look for better profitability but business competence to manage operational activities.
Types of the asset management ratios
The most common types of asset management ratios include total assets turnover, working capital turnover, inventory turnover, receivables turnover, payable turnover, and day’s sales in inventory, etc. Let’s discuss these types in further detail.
1-Total assets turnover ratio
This ratio compares sales generated by the company with total assets as we understand that the business with a higher asset base is expected to generate higher revenue in general. So, this ratio enables stakeholders to compare the revenue-generating ability of the business with other businesses and helps in deciding on an investment.
This ratio is calculated with the following formula.
Asset turnover ratio = sales / Total assets
2-Working capital turnover ratio
This ratio helps to understand how effectively the business utilizes its implied working capital to produce revenue. A higher value of working capital is desirable from an investor’s perspective as it indicates enhanced efficiency.
The ratio is calculated with the following formula.
Working capital turnover ratio = Net annual sales of the business / Average working capital implied
It’s important to note that implied working capital costs money in terms of financial and opportunity costs. So, higher revenue with less working capital is a desirable feature with perspective to investors.
3-Fixed assets turnover ratio
This ratio compares sales generated by businesses with fixed assets, and the concept is the same as in the case of total assets turnover. Hence, a business with higher sales is considered better in terms of efficiency.
This ratio is calculated with the following formula.
Fixed assets turnover = sales / Total fixed assets
However, it’s important to note that some businesses are established with very low Net Book value of the fixed assets and indicate the higher value of the asset turnover ratio.
So, adding small details in the analysis helps perform a better financial analysis of the potential investment opportunity.
4-Inventory turnover ratio
The inventory turnover ratio aims to assess how quickly inventory is used and replaced by the business. If the inventory turnover ratio is higher, it indicates that inventory is replaced more frequently, and less cost is incurred for the working capital management.
The ratio is calculated with the following formula.
Inventory turnover ratio = Cost of goods sold / Average inventory
5-Receivable turnover
The receivable turnover ratio helps to assess the efficiency of the collection function. A higher value of the receivable turnover ratio helps to understand that the business has quality customers that pay their debt on time. On the other hand, lower receivable turnover indicates inefficient funds collection, the inadequacy of credit policy, and problems with the financial status of the customers.
The ratio is calculated with the following formula.
Accounts receivables turnover ratio = Net credit sales / Average accounts receivables
6-Days sales outstanding – DSO
Days sales outstanding ratio helps to measure the efficiency of the collection function in terms of the number of days. The lower value of DSO indicates that the collection function is efficient in recovering funds under debt. On the other hand, a higher value of DSO indicates the business needs to improve its collection.
The ratio is calculated with the following formula.
Days sales outstanding = Average accounts receivables / sales x 365
7-Payable turnover ratio
The payable turnover ratio is not directly asset management ratio. However, it helps to assess the performance of the business in terms of working capital management. Decreasing Accounts payable turnover indicates that the company takes greater time to pay off its obligations, and it may signal a liquidity problem with the business. Alternatively, it can be perceived that the business is efficiently managing its suppliers.
On the other hand, a high value of payable turnover ratio indicates that the business is successfully managing the cash flow. Alternatively, it can be perceived that the business may not be able to negotiate with the suppliers on terms of payment.
This ratio is calculated with the following formula.
Accounts payable turnover = Total supplies purchases / Average accounts payable
Conclusion
Assets management ratios help to assess the efficiency of the business’ operational activities. It helps to understand how the business has been using resources allocated in the business. Potential investors and other stakeholders desire to work for the business with higher efficiency and effectiveness.
These ratios help in the overall financial analysis of the business and provide an in-depth understanding of the operational business processes. Further, these ratios can be assessed in terms of total assets and the break up like inventory, receivables, and other assets.
Also read,
Profitability ratios
Liquidity ratios
Gearing ratios
Assets management ratio is the tool to measure company effectiveness and efficiency in using assets to generate revenue and expand the business. It compares the sale amount with the total balance of the company assets. It will indicate how good management use the assets to make sale for the company. Besides that, It will show the company potential growth when there are many assets invest with less income. It also a sign for management to seek new capital when the company has limited assets which will hurt the sale in the future.
Assets management ratios are calculated for various kinds of assets, but we usually focus on inventory, accounts receivable, fixed assets, and total asset. These ratios will provide different indicators regarding the use of assets and they tell different stories to investors. However, the higher is always the better as it means company use assets effectively will improve company growth.
Assets management ratios are divided into many small ratios such as:
- Inventory turnover
- Days sale in inventory
- Total assets turnover
- Receivable turnover
- Das sale in receivable
- Day Sale Outstanding
- Fixed Assets Turnover
1. Inventory Turnover
Inventory turnover is the number of time which inventory is sold within a year. It is an indicator to show how good management covert inventory to revenue. The faster is the better as the company will be able to generate more revenue and the quality of products also fresh. However, different products will have different inventory turnover, so it is better to benchmark within the same industry to access company performance.
\[Inventory\ Turnover\ Ratio = {COGS \over Average\ Inventory}\]
2. Days Sale in Inventory
Days sale in inventory is the number of days which company spends to sell off all inventory. In other words, it is how long the stock will last.
\[Days\ Sale\ in\ Inventory = {Ending\ Inventory \over COGS * 365}\]
The shorter the company takes to sell off the stock, it will be better as they can make more revenue. But we must check the ordering process to prevent the “out of stock” as it will impact customers’ experience in long term.
3. Total Asset Turnover
Total assets turnover is the comparison of company annual sales with total assets. It will show how well the company uses all assets to generate sales within the year.
\[Total\ Assets\ Turnover = {Total\ Sale \over Average\ Assets}\]
4. Receivable Turnover
Accounts Receivable Turnover is the tool to measure how well the company collects money from credit sales. It shows how many time company can convert accounts receivable into cash. It compares the amount of sales and the outstanding accounts receivable. Cash is very important for the business to pay for the employees, creditors, and other stakeholders. Without enough cash, the company will face the risk of liquidation. Even if the company is making a good profit, it will be a risk if they lack a cash balance.
\[Accounts\ Receivable\ Turnover = {Net\ Credit\ Sale \over Average\ Accounts\ Receivable}\]
In general, the higher is the better, as we need to have cash as soon as possible for paying salary, supplier, and other parties.
5. Working Capital Turnover
Working capital turnover is the ratio which shows how the company uses working capital to make a sale. The higher the better, as it shows the effectiveness of management strategy.
\[Working\ Capital = {Net\ Annual\ Sale \over Average\ Working\ Capital}\]
Fixed Assets Turnover is the ratio that measures the company’s ability to generate sales from the number of fixed assets invested in the company. The higher ratio shows that company is able to generate high sales compare to the invested fixed assets. It compares the amount of sales over the fixed assets.
\[Fixed\ Assets\ Turnover = {Sales \over Fixed\ Assets}\]
7. Day Sale Outstanding
Day sale outstanding is the ratio that measures the average days that company receives cash from the sale. As we know, company is trying to collect the cash from the customers and use it to pay for other parties. If the company spend a too long time collecting cash, the company may not have enough cash to pay for supplier and employee.
\[Days\ Sales\ in \ Inventory = {365 \over Inventory\ Turnover}\]
Purpose of Assets Management Ratio
The assets management ratio is a key metric that investors use to calculate and analyze a company’s financial health. This ratio measures the amount of assets that a company has relative to its liabilities, and it provides insights into a company’s ability to meet its financial obligations. A high assets management ratio indicates that a company has a strong financial position, while a low ratio indicates that a company may have difficulty meeting its obligations. The assets management ratio is an important tool for investors because it can help them assess a company’s financial risk and make more informed investment decisions.
A company’s financial statements can provide valuable insights into its overall health and performance. This information can be used by creditors to assess the company’s ability to generate sales and meet its financial obligations. Financial statements can also be used by shareholders to evaluate management’s stewardship of company resources. In addition, financial statements can be helpful in identifying trends and concerns that may impact the company’s future success. By understanding a company’s financial statements, creditors and shareholders can gain important insights into its overall health and prospects for the future.
Advantage of Assets Management Ratio
- Help the investors to select the best company to invest in: It is essential for investors to do their due diligence before investing in any company. They should look at the financial stability of the company, as well as its history and prospects. The assets management ratio is a set of ratios that investors can use to analyze the company’s performance. They should also consider the management team and board of directors, to ensure that they are experienced and reputable. Furthermore, the company’s business model should be examined to determine whether it is sustainable.
- Allow the comparison between companies: Financial ratios are a helpful tool that can be used to compare different companies. Ratios can be used to measure a variety of factors, including profitability, solvency, and efficiency. By comparing the ratios of different companies, it is possible to get a better understanding of each company’s financial health. Additionally, ratios can be used to identify trends over time, which can be helpful in making investment decisions.
Disadvantage of Assets Management Ratio
- Only focus on sales not profit: Most asset management ratios focus on the efficiency of the company’s ability to generate sales and collect cash. These ratios ignore the company’s profitability which is the ultimate goal of the company. The business may be able to generate huge sales, but it does not mean that they are making a good profit. The company may not able to reduce the cost to an acceptable level to maintain a good profit.
- Based on history data: The investors are able to calculate and analyze the assets management ratio to analyze the best performing company. However, this figure arrive from the past data which already happens last year. It is hard to predict the future base on past data. It will a chance that future performance is different from the past.
- Different capital structures: The ratio such as fixed assets turnover, working capital turnover, and inventory turnover will be different from one company to another. It depends on their capital structure and capital invested. It is hard for investors to compare one company to another.
- Not flexible: The ratios seem not flexible enough for all situations. For example, the fixed assets turnover will rely on the total fixed assets amount even if some of them are not in use. The calculation will rely on the information from the financial statements.
Conclusion
Asset management ratios are useful tools for the evaluation of the efficiency and effectiveness of business operations. These ratios are used to evaluate the company’s ability to use its assets in generating revenues. The ratios may have some limitations, however, they have many significant benefits for the company, investors, and other parties. Asset management ratios are still an essential tool for analyzing a company’s financial performance.