Asset Management Ratios and Generating Revenue
Asset management, also called asset utilization, asset turnover, asset activity and asset efficiency, ratios tell a small business how well their assets are working to generate sales. Cash is always the best asset but it doesn't generate any revenue. The other assets on your balance do generate sales revenue.
Those other assets are accounts receivable, inventory, and fixed assets. You may also have some other assets on your balance sheet but these are the main ones we use to calculate how efficiently your assets are working for you.
Asset management ratios are computed for by the type of asset, for instance, fixed asset turnover, inventory turnover, accounts payable turnover, accounts receivable turnover, and cash conversion cycle. Each provides important insights into specific financial areas of the company and illuminates its strengths and weaknesses.
High vs. Low Asset Management Ratios
High asset turnover ratios are a positive indicator that the company is utilizing its assets efficiently to produce sales. The higher the asset turnover ratios, the more sales the company is generating from its assets. Of course, what's high for one industry may be low for another industry so cross-industry comparisons are not especially useful.
Low asset turnover ratios are a negative indicator - the company is not utilizing its assets efficiently to produce sales.
They are not using their assets well. Perhaps their assets are obsolete or they are running the company below full capacity. Here are some examples:
Accounts Receivable Turnover Ratio
To illustrate the concept of asset management ratios, let's look at receivables turnover, which looks at a company's management of its accounts receivable, which includes its credit policy.
As before, the higher the accounts receivable turnover ratio, the better the company is doing collecting its accounts receivables. One caveat - if the ratio is too high, it may mean that there's too large a discount for early payment, or that the terms are too restrictive.
The account receivables turnover ratio is calculated by dividing sales by accounts receivables.
Days' Receivable Ratio
Along with this, a business owner should also look at the days' receivable ratio to indicate how long, on average, it takes the business to collect on its credit sales to customers. This is also known as the days' sales outstanding (DSO) or average collection period (ACP). The days' receivables ratio is calculated by dividing the number of days in a year, 365, by the receivables turnover ratio.
Inventory Turnover Ratio
If your company sells physical goods, this is the most important asset management or turnover ratio. The calculation is net sales divided by inventory. Net sales come from your income statement and inventory from the balance sheet. The result is the number of times inventory is sold and restocked. If it's too high, look out for stockouts. Too low and you may have obsolete inventory.
Days' Sales in Inventory Ratio
With the inventory turnover ratio, you as the business owner should also look at the days' sales in inventory ratio which will highlight how many days, on average, it takes to sell inventory.
The lower the ratio, the quicker inventory is selling. Days' sales in inventory ratio are calculated by dividing 365 days by the inventory turnover ratio.