Introduction:
Your business is improving; you are growing into success. You decide to invest in other assets to increase your revenues. But do you invest your money or borrow funds? Your money in long-term assets might affect your working capital,, and borrowing too much money increases financing expenses. To answer these questions or situations, you use asset management ratios. These financial ratios measure how effectively your business is using the assets. The results show if assets are too high or too low.
Inventory turnover = Cost of goods sold / Inventory
The inventory turnover measures how many times the inventory is sold and bought back. This represents the inventory cycle of buying it and selling it. The result is a number typically measured in days. For example, a company has $400 thousand in cost of goods sold in the income statement and $45 thousand reported in inventory in the balance sheet. The result is $400,000/$45,000 = 8.88 inventory turnover; if you divide 365 by 8.88, you get 41.10 days.
Please note, if your sales and thus your inventory purchases are subject to seasonality, you should use an average inventory as the denominator. This allows some correction for the inventory highss and lows during the year.
Days sales outstanding (DSO) = Accounts Receivable / [Annual Sales / 360]
You should know this ratio if you maintain a credit policy. Having your clients buy from you with credit terms requires you to measure your accounts receivable. The result is measured in days. The ratio represents how long it takes to convert your accounts receivable into cash. For example, if a company has $55,000 in accounts receivable reported on the balance sheet and $750,000 in total credit sales, the result is $55,000 / ($750,000/360) = 26.4 days of sales outstanding. Please note, in the denominator, you average your sales on a per-day basis; that’s why you divide total credit sales by 360 days. Also, note that you use credit sales since that triggers your credit policy; do not use your cash sales.
Fixed assets turnover = Sales / Net fixed assets
This ratio is calculated by dividing sales in the income statement by the net fixed assets in the balance sheet. For example, if your company has $750,000 in sales and $150,000 in net fixed assets, it equals a ratio of 5. To make sense of this ratio, you should compare it to your competitors or the industry.
Total assets turnover = Sales / Total assets
This ratio measures the turnover of all of the business’s assets. This means how the business is using its assets to generate revenues. Please note that this ratio’s efficiency depends on increasing sales or using fewer assets for generating revenues; thus, profits. Also, you can use an average of total assets to better represent or smooth your balance sheet account. A higher turnover shows more efficiency because it tells that fewer assets are used for revenues.
For example, if your company has $750,000 in sales and $600,000 and $550,000 in the beginning and ending balances, respectively, in total assets. The total assets turnover equals 1.30 If your competitors have a 2.0, then you need to analyze your asset composition to improve your overall situation since there might be some inefficiency. In our example, we use an average of total assets; therefore, we added $600 and 550 thousand and divided by 2; thus, our denominator for this calculation was $575,000 for total assets.
Conclusion:
Asset management ratios should be used, and results must be interpreted with caution. Comparisons should be made between years of the same company and with the industry. Alone, they do not tell much; thus, make sure to use them with as much information as you can gather from competitors and the industry. If not available, then use various years of your business to improve the usability of these ratios.
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