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 stakeholders of a company can determine the efficiency and effectiveness of the company’s 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.
The purpose of why stakeholders calculate asset management ratios depend 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 asset turnover ratio of a company 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 considered the fixed assets of a company to evaluate its efficiency.
Asset turnover = Sales / Fixed Assets
3) Net Working Capital Turnover
The Net Working Capital Turnover is a ratio which 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 as compared to using total assets. The higher this ratio is for a company, the better it is using its working capital in generating 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. While a higher Inventory Turnover Ratio is preferable, if it is too high, it can also indicate a risk of stockouts. 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. Expressed in a number of 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 a number of 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
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 the performance of a company in a specific area, for example, working capital management. Therefore, they can also help companies in controlling their assets and generating 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.
There are several limitations of asset management ratios as well. Most importantly, these ratios consider the revenues of a company and neglect its profits. 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 result 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.
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.