Asset Turnover ratio is one of the important financial ratios that depicts how the company has been utilizing its asset to generate turnover or sales.
Asset Turnover ratio compares the net sales of the company with the total assets. It measures per rupee investment in assets used to generate amount of sales.
There are different versions of the ratio which depends on what type of asset is to be considered.
The formula to calculate this ratio is
Asset Turnover Ratio = Net Sales/ Average Total Assets
Here, Net sales is after sales return as well as sales discount. Average total assets is calculated after dividing the opening and closing balance of the assets by 2.
Various popular variations of this ratio include Fixed Asset Turnover Ratio, Current Assets Turnover Ratio among others.
A higher ratio indicates that assets are being utilized efficiently while the lower ratio reflects ineffective management of the assets.
Let’s discuss how the assets turnover ratio can be improved:
- Improve Debtors Collection: The slow pace of collection of accounts receivables increases the chance of lowering the sales. This reduces asset turnover ratio. By preparing and strictly adhering to a debtor’s policy, the company can actually improve the assets turnover ratio. This can be done by outsourcing the collection task to collection agency, hiring an employee overseeing accounts receivable or reducing the debtors credit period to at least industry norms.
- Improve Revenue: Improving revenue is easiest way to a healthy asset turnover ratio. The company needs to move its stock effectively and engage in promotional activities through advertisements. The company can also the examine the warehouse to ascertain whether there are slow moving stocks held in the warehouse. The company should find a way to move those slow-moving goods quickly.
- Liquidate Assets and Improve Efficiency: The company needs to have proper asset plan which deals with purchase and sale of assets strategically. Obsolete assets should be sold quickly as they are of no use to the contribution to sales and only makes the balance sheet look poor to the stakeholders. Assets frequently used should be regularly maintained in a scheduled manner while on the other hand, assets that are not frequently used, the company should arrive at strategic decision-making process whether to discard, replace or repair the assets. Bottleneck activities should be removed on the spot. If the company has delivery vehicles, the management should have a plan in place making sure that these vehicles leave the warehouse at full capacity delivery all the goods traveling the least. The management should also make effort to find various other ways to increase the efficiency of the asset.
- Take Assets on Lease: Well, this is not a fool proof way to improve assets turnover ration but on technical grounds, this can be used. If the company takes the assets on lease, the value of assets is not on balance sheet and is shown in Profit and Loss Account. The denominator i.e. of Average Assets in calculation of Assets Turnover Ratio is technically lower, thus, resulting in higher assets turnover ratio.
- Formulate Robust Inventory Management: The company should analyze how its stock move from company to its customer and know whether there are slow moving or fast-moving products of the company. The company can have slow or ineffective delivery system that can result in delay of service which in result will delay in collection period of accounts receivable. Hence, the company should computerize the process of order taking, inventory management and billing in order to improve and effectively manage cash flows of the company. This will eventually show up in sales numbers and improve the asset turnover ratio.