Asset Management Ratios: Definition, Formula, Example, More

Definition

Asset management ratios are a group of metrics that show how a company has used or managed its assets in generating revenues. Through these ratios, the company’s stakeholders can determine the efficiency and effectiveness of the company’s assets management.

Due to this, they are also called turnover or efficiency ratios. As the name suggests, these ratios usually consider only two factors, a company’s assets and revenues.

Since companies have various types and classes of assets, there are also different ratios for different assets. Some of the most commonly used asset management ratios include inventory turnover, accounts payable turnover, days sales outstanding, days inventory outstanding, fixed asset turnover, receivable turnover ratios, and cash conversion cycle.

Purpose

The purpose of why stakeholders calculate asset management ratios depends on the type of stakeholder. Usually, asset management ratios are crucial for investors and shareholders.

Through these ratios, they can calculate the efficiency and effectiveness of their investments. Usually, the better these ratios are, the higher the chances of investors and shareholders investing in the company.

Furthermore, these ratios allow stakeholders to analyze the financial performance of a company from multiple aspects. Usually, stakeholders prefer companies with higher profits.

However, judging companies by the amount of their profit is not suitable for comparisons. Similarly, just because companies can make profits doesn’t mean they are using their assets effectively.

Therefore, asset management ratios can help with all these aspects and much more.

Assets Management Ratios

Some of the most commonly used asset management ratios are as below.

1) Total Asset Turnover

The Total Asset Turnover is a ratio that measures the efficiency of a company in the use of all its assets to produce sales. It gives a summary of all the asset management turnover ratios.

The higher the company’s asset turnover ratio is, the better and more efficient it is considered by stakeholders.

Asset turnover = Sales / Total Assets

2) Fixed Asset Turnover

The Fixed Asset Turnover is a ratio that measures the efficiency of a company in the use of only its fixed assets to produce sales.

This ratio only considers the use of long-term assets as compared to short-term. While it is a type of asset turnover ratio, some stakeholders prefer only to consider the company’s fixed assets to evaluate its efficiency.

Asset turnover = Sales / Fixed Assets

3) Net Working Capital Turnover

The Net Working Capital Turnover is a ratio that signifies the efficiency of a company in using its working capital. It is also a type of asset turnover ratio.

However, this ratio is usually a better indicator of a company’s operations than using total assets. The higher this ratio is for a company, the better it uses its working capital to generate revenues.

Net Working Capital Turnover = Sales / Net working capital

4) Inventory Turnover Ratio

Another asset management ratio that is considered critical is the Inventory Turnover Ratio. It shows how many times the company has sold and restocked its inventory within the accounting period under consideration.

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While a higher Inventory Turnover Ratio is preferable, it can also indicate a risk of stock outs if it is too high. A low ratio, on the other hand, may indicate slow-moving inventory.

Inventory Turnover Ratio = Net Sales / Inventory

5) Days Sale in Inventory

Another inventory-related asset management ratio is the Days Sale in Inventory. It is expressed on many days. It calculates the time it takes a company to sell off all its inventory.

Simply put, it shows how much time it takes the company to convert stock into sales. For this ratio, the lower the number of days, the better it is.

Days Sales in Inventory = 365 (days) / Inventory turnover

Another formula to calculate the ratio is as follows.

Days Sales in Inventory = Inventory / Cost of Goods Sold x 365 days

6) Receivables Turnover

Receivables Turnover is a ratio that measures how many times a company collects its accounts receivable balances. This ratio depends on the credit policies of a company. A higher Receivables Turnover ratio means the company collects its credits promptly.

Receivables Turnover = Sales / Accounts Receivable

7) Days Sales Outstanding

The Days Sales Outstanding ratio measures the efficiency of a company in recovering its receivables. Similar to the above ratio, the DSO expresses the result in many days.

A lower DSO means that a company is recovering its receivables in a short amount of time. Shorter receivable collection periods can also be beneficial in avoiding bad debts. Other names for this ratio are Average Collection Period or Days Sales in Receivables.

Days Sales Outstanding = Accounts Receivable / Sales x 365 days

8) Payables Turnover Ratio

Accounts payable aren’t the assets of a company. Nonetheless, they are a part of a company’s working capital management.

The Payables Turnover shows how quickly a company makes payments to its suppliers for credit purchases. A high ratio means that the company pays its bills in a short amount of time. A low ratio may be an indicator of cash flow problems.

Payables Turnover Ratio = Purchases / Accounts Payable

Importance

Asset management ratios are highly significant in their importance. First of all, these ratios help determine the efficiency and effectiveness of a company.

Without these ratios, making comparisons between the performance of various companies becomes complex. Similarly, asset management ratios play a significant role in helping investors in making decisions.

Similarly, these ratios can indicate a company’s performance in a specific area, for example, working capital management.

Therefore, they can also help companies control their assets and generate the maximum possible revenues for the limited resources they have.

Asset management ratios also signify the fact that only considering a company’s revenues is not crucial. It is also critical to take its usage of assets into account.

Limitation

There are several limitations of asset management ratios as well. Most importantly, these ratios consider the revenues of a company and neglect its profits.

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While generating higher revenues is critical for companies, they must also weigh their profits. Generating higher revenues while lacking the capacity to convert them into profits is futile.

Similarly, these ratios consider the historical information of a company. It means investors must also consider other aspects of the business of a company along with these ratios.

Furthermore, these ratios may return inaccurate results sometimes, for example, when companies have assets they don’t use anymore. Lastly, these ratios are also subject to manipulation due to their dependency on information obtained from financial statements.

Tips to Increase Asset Management Ratios:

Asset management ratios are financial ratios that help to measure a company’s effectiveness in managing its assets to generate profits.

Here are some tips to increase asset management ratios:

  1. Increase asset turnover: The asset turnover ratio measures how efficiently a company uses its assets to generate revenue. To increase asset turnover, a company can reduce inventory, sell unproductive assets, and increase sales.
  2. Improve inventory management: Effective inventory management can help a company reduce excess inventory, minimize waste, and optimize production processes. This will lead to improved asset management ratios.
  3. Reduce accounts receivable turnover: Accounts receivable turnover measures how effectively a company collects its accounts receivable. To improve this ratio, a company can implement stricter credit policies, incentivize early payments, and automate invoicing processes.
  4. Optimize fixed assets: A company can optimize its fixed assets by maintaining them properly, minimizing downtime, and reducing maintenance costs. This will improve asset utilization and efficiency.
  5. Increase cash flow: A company can increase its cash flow by optimizing its working capital, reducing debt, and increasing revenue. This will lead to improved liquidity and asset management ratios.
  6. Implement effective cost control measures: Effective cost control measures can help a company reduce unnecessary expenses, improve profitability, and increase its asset management ratios.

Tips to Decrease Asset Management Ratios

Asset management ratios are essential metrics used to evaluate the efficiency of a company using its assets to generate revenue. 

Lower asset management ratios indicate that a company is using its assets more effectively, which can improve profitability. 

Here are some tips to decrease asset management ratios:

  1. Increase sales revenue: A company can increase its sales revenue by improving its marketing strategies, expanding its product or service offerings, and/or entering new markets. By generating more revenue, a company can increase its asset turnover ratio, which measures how efficiently it uses its assets to generate revenue.
  2. Reduce inventory levels: More inventory ties up a company’s working capital and can lead to obsolescence and waste. By reducing inventory levels, a company can improve its inventory turnover ratio, which measures how efficiently it turns over its inventory.
  3. Improve collection of receivables: A company can improve its collection by implementing stricter credit policies, offering discounts for early payments, and actively following up on overdue amounts. By collecting receivables more quickly, a company can improve its accounts receivable turnover ratio, which measures how efficiently it contains customer payments.
  4. Sell unproductive assets: Selling ineffective or underutilized assets can free up working capital and improve asset turnover ratios. A company can also lease or rent assets rather than purchase them outright.
  5. Reduce fixed costs: Fixed costs, such as rent, salaries, and insurance, can reduce a company’s profitability. By lowering fixed costs, a company can improve its return on assets (ROA), which measures how efficiently it uses its assets to generate profits.
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What Are the Risk of Not Maintaining Asset Management Ratios Effectively?

Asset management ratios are essential tools for evaluating the financial health of a business or organization. 

They provide insight into how well the company utilizes its resources, manages its debts, and generates profits. 

Failure to maintain these ratios effectively can lead to a variety of risks for the company, including:

  1. Poor financial performance: If the asset management ratios are maintained effectively, it can result in better financial performance. For example, suppose the company needs to manage its assets more efficiently. In that case, it may have too much inventory or too many receivables, leading to cash flow problems and poor financial performance.
  2. Decreased liquidity: Effective asset management ratios can ensure the company has enough cash to cover its obligations. If these ratios are not maintained properly, the company may not have sufficient liquidity to meet its short-term obligations, such as paying suppliers or employees.
  3. Increased debt: Poor asset management ratios can also lead to increased debt levels for the company. For example, suppose the company needs to generate more profits to cover its expenses. In that case, it may need to borrow more money to stay afloat, which can lead to an unsustainable debt burden.
  4. Reduced profitability: Effective asset management ratios can increase profitability by optimizing the use of company resources. If these ratios are maintained properly, the company may be able to maximize its profits, which can lead to reduced profitability and, potentially, lower shareholder value.
  5. Poor investment decisions: If asset management ratios are not maintained effectively, it can also lead to poor investment decisions. For example, if the company is not managing its assets efficiently, it may need more resources to invest in growth opportunities, limiting its potential for long-term success.

Average Asset Management Ratio by Industries

IndustryAsset Management RatioBenchmark
RetailInventory turnover ratio6-8 times per year
ManufacturingFixed asset turnover ratio2-3 times per year
BankingLoan-to-deposit ratio80-90%
Real EstateGross rental yield5-8%
HealthcareBed utilization rate65-85%
TransportationAsset utilization rate60-70%
TechnologyReturn on assets (ROA)10-15%
AgricultureCrop yield ratioVaries widely by crop type
EnergyProduction efficiency ratioVaries widely by energy source
HospitalityOccupancy rate60-80%

Conclusion

Asset management ratios are necessary for the evaluation of the efficiency and effectiveness of a company. These ratios indicate how well a company uses its assets in generating revenues.

The purpose of these ratios depends on the user. Asset management ratios are of significant importance, although they may have some limitations.