Asset management Ratios - Definition, Formula, Example and More

What are Asset management Ratios?

Asset management ratios are a group of metrics that show how a company manages its assets in generating revenues. They’re used to analyze how efficiently and effectively a company is using its resources by comparing the total assets with the total sales. These ratios can be used in the context of investing, when considering whether to purchase stock in a company or not. They can also help determine risk tolerance levels by measuring risk-to-reward portfolio weights.

For accurate asset management ratios, companies have to ensure that each operation carried out is well recorded. Ethics in accounting will be key during the accounting process to ensure that high degree of credibility and honesty is upheld.

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Types of Asset Management Ratios and How to Analyze Them

There are quite a few different asset management ratios commonly used. These include the following:

1. Total Asset Turnover Ratio

Total asset turnover ratio measures the ability of a company or organization to generate sales from its assets. This is done by comparing a company’s net sales by its total assets. A company with a high asset turnover ratio operates efficiently compared to its competitors

The formula for the asset turnover ratio is as follows:

Total Sales = Annual sales total
Beginning Assets = Assets at start of year
Ending Assets = Assets at end of year
Total Assets = {(Beginning Assets + Ending Assets) / 2}

Example 1

Maxime Company reported beginning total assets of $160,000 and ending total assets of $230, 250. Over the same period, the company generated sales of $270, 500. Calculate the asset turnover ratio for Maxime Company:

Solution

Total Asset Turnover Ratio = $270, 500 / {($160,000 + $230,250)/2}

= $270, 500 / {$390, 250/2}

= $270,500 / $195,125

= $1.38

Therefore, for every dollar in total assets, Maxime Company generated $1.38 in sales.

Example 2

Kenbiz Company is Fashion Startup Company that designs clothes. Kenbiz is currently looking for new investors and has a meeting with an investor. The investor wants to know how well Kenbiz uses his assets to produce sales, so he asks for her financial statements.

Here is what the financial statements reported:

Beginning Assets: $70,000
Ending Assets: $140, 000
Net Sales: $35, 000

The total asset turnover ratio is calculated like this:

Total Asset turnover ratio = $35,000 / {($70,000+$140,000) /2}

= $35,000 / {$210,000/2}

= $35,000 / $105,000

= $0.33

Kenbiz ratio is only 0.33. This means that for every dollar in assets, Kenbiz only generates 33 cents. In other words, Kenbiz start up in not very efficient with its use of assets.

To evaluate performance of your company, you should compare this ratio to prior periods or industry average ratios. You can also compare it to other companies in the same industry.

2. Net Working Capital Ratio

This ratio examines the ability of a company or business to pay off its current liabilities with its current assets. It is intended to provide information on the business liquidity to determine if it has sufficient amount of net funds available in the short term to stay in operation.

Current assets are items that will be used during the current period. Liabilities are items which must be paid as they are incurred (such as accounts payable, accrued expenses, and accrued income), and bills payable.

Net Working Capital = Current Assets – Current Liabilities

Net Working Capital Ratio = Current Assets/Current Liabilities

Decision: Analysts believe that the ideal NWC ratio should fall between 1.2 and 2 but may vary from industry to industry. This mean that you have between 1.2 times and twice as many current assets as you do short-term liabilities.

Example

WHU Company provided the following information;

For current assets, WHU Company has:

$500,000 in cash and cash equivalents.
An accounts receivable balance of $55,250
Inventory worth $75,100

For the balance sheet, it has:

A short-term loan for $250, 000
An accounts payable balance of $75,000
Accrued liabilities of $50,200

Plugging these values into our net working capital formula, we get:

Net Working Capital = Current Assets – Current Liabilities

Total Current assets = $500,000 + $55,250 + 75,100

= $630,350

Total Current liabilities = $250, 000 + $75,000 + $50,200

= $375,200

Net working capital (NWC) = Current assets – Current liabilities

= $630,350 – $375,200

=$255,150

Therefore WHU Company has a net working capital balance of $255,150. This compares favorably to last year, when its NWC balance was $80,000 calculated from {$500,000 (total current assets)- $ 420,000 (total current liabilities)}

If we can further proceed and calculate the net working capital ratio for the current year, we will get;

$630,350 ÷ $375,200= 1.68

The current ratio for the previous year was;

$500,000 ÷ $ 420,000 = 1.19

The current ratio for the current year much better than the previous year’s since the current NWC ration is 1.68 and the previous year it was 1.19

WHU Company has a fairly healthy NWC ratio and is making good use of its current assets, compared to the previous year, which fell just below the ideal range for the NWC ratio and put them at risk of failing to cover their short-term debts.

However, depending on the nature of their business, WHU Company may want to keep an eye on inventory levels to ensure they don’t have too much of their capital tied up in assets that may depreciate before they can be sold.

3. Accounts Receivable Turnover Ratio

Also known as debtor’s turnover ratio. It analyzes how quickly a company collects cash from its customer’s accounts. This ratio shows how effective a company is at collecting past due receivables.

It divides the annual net credit sales by the average accounts receivable for the same year.

How to calculate Receivable Turnover Ratio;

The accounts receivable turnover ratio formula is as follows:

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Where:

Net credit sales are sales where the cash is collected at a later date. Its calculated by taking Sales on credit – Sales returns – Sales allowances.
Average accounts receivable is the sum of starting and ending accounts receivable over a time period (such as monthly or quarterly), divided by 2.

Example

Sammy enterprise is a wholesale store that sells products to retailers. Due to declining cash sales, Sammy, the CEO, decides to extend credit sales to all his customers. In the fiscal year ended December 31, 2018, there were $80,000 gross credit sales and returns of $7,000. Starting and ending accounts receivable for the year were $8,000 and $12,000 respectively. Sammy wants to know how many times his enterprise collects its average accounts receivable over the year.

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Receivable Turnover Ratio =$80,000 – $7,000 ÷ {($8,000 + $12,000) / 2}

= $73,000 ÷ {$20,000 / 2}

= $73,000 ÷ $10,000

= 7.3

Therefore, Sammy Enterprise collected its average accounts receivable approximately 7.3 times over the fiscal year ended December 31, 2018.

Accounts Receivable Turnover in Days

The accounts receivable turnover in days shows the average number of days that it takes a customer to pay the company for sales on credit.

The formula for the accounts receivable turnover in days is as follows:

Accounts Receivable turnover in days = 365 / Accounts Receivable Turnover Ratio

Determining the accounts receivable turnover in days for Sammy Enterprise in the example above:

Accounts Receivable turnover in days = 365 / 7.3 = 50
Therefore, each customer takes an average of 50 days to pay their debt.

Assuming that Sammy Enterprise maintains a 30 day policy for payments made on credit, the receivable turnover in days calculated above would indicate that on average, customers make late payments.

4. Fixed Asset Turnover Ratio

This ratio is used to determine how effectively a company is utilizing its fixed assets (such as land and buildings) to generate sales. It divides the annual revenue by the total net fixed assets for a period of time. You can use this ratio to evaluate how efficiently a company is utilizing its facilities, or if it’s over-leveraged.

Generally, a higher fixed asset ratio implies more effective utilization of investments in fixed assets to generate revenue.

Fixed Asset Turnover (FAT) = Average Fixed / Assets Net Sales

Where:

Net Sales = Gross sales – returns – allowances

Average fixed assets = NABB−Ending Balance / 2

Where;

NABB=Net fixed assets’ beginning balance

Example

Mejja’s Automotive Garage is an establishment where automobiles are repaired by auto mechanics and technicians. Mejja is applying for a loan to expand his garage space. His sales for the year are $200,000 using equipment he paid $70,000 for. The accumulated deprecation on the equipment is $35,000

Let us calculate Mejja’s Assets Turnover Ratio

Here’s how the bank would calculate Jeff’s turn over.

Fixed Asset Turnover Ratio = Average Fixed / Assets Net Sales

Average Fixed = $200,000

Assets Net Sales = $70,000 – $35,000 = $35,000

FAT= $200,000 / $35,000

=5.71

From the above calculation it is evident that Mejja generates roughly six times more sales than the net book value of his assets. The bank should therefore compare this metric with other companies in the same industry as Mejja because you may find that a 6x metric might be good for the food industry, but it might be horrible for the automotive industry.

When the business is underperforming in sales and has a relatively high amount of investment in fixed assets, the FAT ratio may be low. A declining ratio may also suggest that the company is over-investing in its fixed assets.

A high ratio, on the other hand, is preferred for most businesses. It indicates that there is greater efficiency in regards to managing fixed assets; therefore, it gives higher returns on asset investments.

Fixed assets vary significantly from one company to another and from one industry to another, so it is always important to compare ratios with other companies’ in the same industry as you.

5. Inventory Turnover Ratio

This ratio is used to determine how quickly a company is selling its inventory by comparing cost of goods sold with average inventory for a period. You can use this ratio to evaluate how quickly a company can restock itself, or if it’s overstocked.

This ratio is important because total turnover depends on two main components of performance. The first component is stock purchasing. If larger amounts of inventory are purchased during the year, the company will have to sell greater amounts of inventory to improve its turnover. If the company can’t sell these greater amounts of inventory, it will incur storage costs and other holding costs.

The second component is sales. Sales have to match inventory purchases otherwise the inventory will not turn effectively. That’s why the purchasing and sales departments must be in tune with each other.

Formula

The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period.

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Example

Fiji Furniture Company sells furniture for homes and office buildings. During the current year, Fiji reported cost of goods sold on its income statement as $800,000. Fiji’s beginning inventory was $2,400,000 and its ending inventory was $3,350,000. If we were to calculate Fiji’s Inventory turnover ratio this is how we would go about it;

Inventory Turnover Ratio = Cost of goods sold / Average Inventory

= $800,000 / {($2,400,000 + $3,350,000) / 2}

= $800,000 / {$5,750,000 / 2}

= $800,000/ $4,075,000

Inventory Turnover Ratio = 0.20

From the calculations above Fiji’s turnover is 0.20 which means that Fiji furniture only sold a quarter of its inventory during the year. It also implies that it would take Fiji furniture approximately 5 years to sell his entire inventory.

To calculate days sales of inventory you will use the formula below;

Days Sales of Inventory (DSI) = 365 ÷ Inventory Turnover Ratio

In our case above the Days Sales of Inventory will be;

= 365 ÷ 0.2 = 1825 days

= 1825 days translates to 5 years

High turnover rates reduce storage and other holding costs.
Low turnover implies that a company’s sales are poor, it is carrying too much inventory, or experiencing poor inventory management. Unsold inventory can face significant risks from fluctuating market prices and obsolescence.
In order to make a good decision ensure you compare the ratios between companies operating in the same industry and not for companies operating in different industries.

Do you have a managerial accounting homework that involves calculation of asset management ratios and you are stuck in computing the figures? We have a team of qualified experts who understand the importance of accounting in your daily life and are ready to provide a quality answers that will guarantee you good grades.

Uses of Asset management Ratios

There are several uses for asset management ratios. These include the following:

1. Analyze your company’s performance

Asset management ratios can be used to analyze how efficiently and effectively your company is using its resources. For example, if you were changing CEOs, you could measure the performance of the previous CEO using these ratios in comparison to industry average or prior periods. You could also use them to see how well your company is meeting its strategic goals and objectives. This would allow you to evaluate how effective a CEO is at executing strategies.

2. Monitor your company’s progress

Assets management ratios can be used to monitor your company’s performance over time. You can use them to see how well it is meeting key performance indicators and if there are any trends. For example, you could use the inventory turnover ratio to determine if your company needs more space or a different distribution strategy.

3. Evaluate a new investment

When evaluating a new investment, you should use these ratios to properly analyze how well the company is using its assets and resources. You can then determine if the investment is worth your money.

4. Predict Future Performance

Asset management ratios can be used to predict future performance. For example, if a company’s inventory turnover ratio is low, it may have inventory issues and might not be able to meet customer demand in the future.

5. Evaluate Current Investments

You can also use these ratios to evaluate your current investments. This will allow you to determine what’s working and what’s not working in a given investment portfolio, allowing you to make adjustments as necessary.

Overall, asset management ratios are an effective tool for evaluating company performance and making investment decisions. They can also be used to determine risk tolerance levels.

What Do Asset Management Ratios Indicate

1. How effectively a company is using its assets and resources

Asset management ratios can be used to evaluate how effectively a company is using its assets and resources. They can be used to determine if the company has an over-leveraged position and if it needs more capital. Ratios such as the inventory turnover ratio and accounts receivable turnover ratio are very telling in this case.

2. Make investment decisions

Asset management ratios can also be used to determine how much a company needs to invest in an asset. For example, if your company’s accounts receivable turnover ratio is low, the company may not have enough sales to cover its accounts receivable. As a result, the accounts receivable will continually cause cash flow problems for the company.

3. Evaluate industry ratios and benchmarking

Asset management ratios are also very useful when used in conjunction with industry averages or benchmarking scores. You can use these industry averages to determine how well your company is performing compared to other companies in the same industry.

4. Determining if a company is over-leveraged or under-leveraged

In asset management, there are two states an investor can be: under-leveraged or over-leveraged. An under-leveraged investor has more assets than liabilities, while an over-leveraged investor has more liabilities than assets. In the asset management industry, this is referred to as “economies of scale.” An over-leveraged investor has too much debt in relation to its assets, while an under-leveraged investor has too few assets in relation to its liabilities.

Advantages of Asset Management Ratios

1. Take the pressure of the CEO

Many companies do not like to give their CEOs money to manage. This has led to the rise of asset management ratios, which can be used as a low-cost way of evaluating company performance. Since most CEOs are being paid based on how successful they are at growing profits, using these ratios is a way for them to make money without making mistakes.

2. Measure the CEO’s performance

Asset management ratios are a simple and effective way to evaluate the performance of CEOs. If a CEO is successful, then he or she will be given more resources to work with. If he cannot meet expectations, then he will be given less resources and he will not be paid as much.

3. Low-cost alternative

Asset management ratios are a low-cost alternative to other forms of management. They allow you to evaluate your strategy without spending a lot of money.

4. Measure industry trends

Using asset management ratios allows you to see how well your industry is performing compared to other industries in the same market segment. This provides you with great benchmarks and insights into what’s working and what’s not working in your industry.

Disadvantages of Asset Management Ratios

There are several disadvantages to asset management ratios, as well as to any type of evaluation.

1. Can be used as an excuse

Asset management ratios can be used as an excuse for poor performance, especially if the company is having a difficult time meeting financial expectations. In some industries, where demand is low and competitors are making a killing, under-leveraged companies may have no choice but to continue having insufficient sales.

2. Uses aggressive terms

Asset management ratios can also be used for aggressive purposes. If an investor is expecting to make money, he may be disappointed whenever a company’s asset management ratio falls below a certain level. This can lead to the investor losing faith in the company, causing the company’s stock to fall.

3. Won’t help you avoid investing in an under-performing company

Asset management ratios can be misleading when used to make investment decisions. They are meant to evaluate the efficiency of a company’s resources, and not necessarily the future performance of a company. Using these ratios may lead you to invest in under-performing companies, even though you had no reason to do so.

4. Limited value

Asset management ratios can have limited value if your strategy is not very specific. For example, if you use asset management ratios but do not indicate what your strategy is, then your ability to evaluate using these ratios is limited.

Using asset management ratios can be a powerful way to evaluate the efficiency of a company. They can also be used to look at trends in an industry and to determine how effective a CEO is at growing profits. However, these ratios can be misleading and should only be used as part of an overall evaluation strategy.

How to Improve The Asset Turnover Ratio

You can improve the asset turnover ratio by:

1. Decreasing expenses

If expenses are too high, then it will be harder for the company to generate profits. This will also increase its risk of incurring more losses.

2. Increasing revenue by increasing sales

By increasing sales a company can: Increase the amount of money it has available Decrease its risk of incurring more losses Grow at a faster rate

3. Decreasing the assets used to generate sales

Assets like inventory, raw materials, and other supplies must be converted into revenue to generate profits. If a company is using too many assets to generate sales, it may not have enough money left over after doing so. This can lead to a negative ROI.

Asset management ratios are important in evaluating the efficiency and effectiveness of any company. These ratios are key in decision making at every stage of investment by either the management or stakeholders. Companies should also remember to follow the Generally Accepted Accounting Principles that creates clear, consistent and comparable financial information important for decision making.

More Resources

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