Asset management ratios explain how potentially a business is using the company’s assets to gain revenue through various groups of metrics.
The asset management ratio analysis highlights the ability to convert or manipulate their assets for sales. This further aids the stakeholders to examine the effectiveness and efficiency of asset management.
The term can interchangeably be used by terms asset efficiency ratios and asset turnover ratios. Therefore, as the name defines, the asset management ratio takes into consideration only two components i.e assets and revenues.
Characteristics of Asset management ratio
Companies have different kinds and classes of assets, with various ratios for different assets. As a result, commonly used asset management ratios may be subcategorised into accounts payable turnover, inventory turnover, days sales outstanding, fixed asset turnover, days inventory outstanding, cash conversion cycle, and receivable turnover ratios.
- Different ratios give an insight into various financial areas of business by pointing out the strengths and weaknesses.
- Preferably high asset management ratios are required to explain that the business uses assets efficiently for sales forecast definition.
- However, a low asset turnover ratio may occur to the assets being obsolete or are operating less than their total capacity.
- Although it cannot be used to compare records or for asset management ratio analysis since requirements vary from industry to industry. Which concludes the unwise comparison between a company which requires fewer assets to manufacture like e-commerce to a company with large facilities, equipment and plants.
- However, asset management ratios have not always been successful as they tend to deviate from their insights where companies sell profitable products at the high margins not often.
Types of Asset Management Ratios
Few commonly used asset management ratios which can be discussed and used frequently by the companies are as follows:
Total Asset Turnover ratio
The total asset turnover ratio explains the efficiency to use the assets for incorporating total sales. Asset turnover provides a summary of the overall asset management ratios. The higher the ratio, the better the situation is considered by the interest holders. This can be explained with help of an asset turnover ratio formula.
Asset turnover ratio formula = Sales / Total Assets
Asset management ratios examples may include the following case for better understanding. Suppose a tech company manufactures tablet computers were his beginning assets = Rs. 50,000, Ending assets are Rs. 100,000 and Net sales are worth Rs. 25,000. The investor wants to know asset turnover.
Asset turnover ratio formula = 25000 / ( 50000 + 100000 /2) = 0.33
As per the asset management ratios, examples discussed the ratio stands at 0.33. Which highlights every rupee asset the tech company can generate 33 paise only. Furthermore stretches that the company is not using their assets efficiently.
Fixed Asset turnover ratio
The fixed asset turnover considers only the efficiency of the company concerning fixed assets to produce sales. In short, thinking long term assets to short. Although this is a part of the asset management ratio few stakeholders only count fixed assets to analyse the efficiency.
Fixed Asset turnover formula = Sales / Fixed Assets
Net Working capital turnover ratio
Considering only significance related to the working capital of the company, its efficiency is calculated. Also a kind of asset management ratio. Although net working capital gives better judgement for operations rather than total assets. Furthermore, the higher the net working capital ratio of the company, the better utilisation is conquered to generate revenues.
Net working capital turnover = Sales / Net working capital
Inventory turnover ratio
Another critical asset management ratio can be counted as the inventory turnover ratio. It explains the number of times businesses restocked and sold their inventory in one accounting period.
However, the higher inventory turnover is required to be maintained for greater profits ( also termed as margin of safety percentage) but might indicate the risk of stockouts with too high a ratio. On the other hand, a lower ratio signifies slow-moving inventory.
Inventory turnover ratio = Net sales / Inventory
Days sale in inventory
This kind of asset management ratio indicates many days. It elaborates on the days taken by the company to wind up its entire inventory. Simply explaining the time depicted by the business to convert their stock. For this ratio, the lower the days better is the situation of the company.
Days sales in inventory = 365 days / Inventory turnover OR (Inventory / Cost of goods sold) x 365 days
Receivables turnover Ratio
These asset management ratios explain the times a company collects their account receivables balance amount. However, the receivables turnover ratio corresponds to the company’s credit policy. A higher receivables turnover ratio highlights company credit collecting to be prompt.
Receivables turnover ratio = Sales / Accounts Receivables
Days sales in outstanding
Days sales in outstanding ratio indicate the business recovering time for its receivables. Similar to the above ratio mentioned, the day’s sales in outstanding is expressed in days.
Lower the ratio better is than the position of the company indicating a shorter amount of time invested in collecting the receivables. This may also benefit in avoiding the bad debts of the company. Other terms commonly used for this asset management ratio can be days sales in receivables or average collection period.
Days sales outstanding = (Accounts receivable / Sales) x 365 days
Payable Turnover Ratio
Payables do not come under the category of assets for the company. However, it is still a part of business working capital management. As a result, the payables turnover ratio depicts the conversion of the payment to the creditors. The high payable ratio highlights how quickly the company pays its bill in a short period. While low ratios may indicate cash problems.
Payables turnover ratio = Purchases / Accounts payable
Interpretation of Asset Management Ratio
Most of the asset management ratios formulae have sales being their numerator while assets of various forms like total, fixed etc as the denominator. So the assets change accordingly. Therefore, the following are a few interpretations of the asset management ratio:
Asset management ratio > 1
A higher ratio while pursuing asset management ratio analysis is always performed. This reflects the optimum utilisation of business assets to incorporate the funds.
The ratio above 1 indicates that the proportion of sales generated is higher than the total quantity of assets which are in use making the company productive. The better the ratio, the better the company’s position to the competitors working in the same industry.
Asset management ratio < 1
The asset management ratios going less than 1 indicates either the assets are not effectively used to produce sales or excessive deployment has been carried out of the assets for the company. The ratio explains that the proportion of assets is comparatively more than the proportion of sales in the company.
As discussed earlier lower the ratio more pathetic will be to the situation of the company’s efficiency regarding the competitors in the same industry. However, this may occur due to expansion or investments that need to be put in use by the business.
Asset management ratio = 1
Although seeming to be perfect but this condition is not appreciated or desired by the company. A ratio equal to 1 explains that the proportion of assets is the same as sales in the business. Moreover, these ratios stand valid when compared in the same industry.
Advantages of Asset management Ratios
- The asset management ratio aids the stakeholders and the company with decision making. Asset management ratio analysis helps to decide the quantum of investments in assets.
- Explains the operations effectiveness and efficiency of the company. Since depending upon the profits might be misleading.
- Can be used to compare two or more firms within the same industry. As a result, the inter-firm comparison becomes handy. The possibility of one firm earning higher profit may occur but the former would be accompanied by the worst Asset management ratios.
- Not only one method can be used to elaborate on the situation of the company. Various asset management ratios as discussed could be helped with depending upon the class of assets.
- As a result, the advantages hold the nature of non-exhaustive.
Disadvantages of Asset management ratios
- The biggest limitation addressed for the asset management ratios could be consideration of only sales revenue and avoiding the company’s profits. In a few cases, the business might earn high sales but struggle with the gross or net profits. Therefore, depending on it creates an indication of misleading.
- The asset management ratios analysis relies on past data or financial statements. Therefore, the fact of manipulation can occur with high chances.
- Moreover, the asset management ratios do not address whether a firm can be capital intensive or labour-intensive. If the business is labour-intensive, then the assets would be lesser than the capital-intensive firm. Therefore, a comparison of such kind could only be possible in the same industry. But comparing industries could give the wrong interpretation.
How do improve asset management Ratios?
Since the asset management ratio covers mainly the assets of the company regarding sales, the explanation could be carried forward concerning the asset turnover ratio. Therefore, when the business ratio declines with time, several ways could be used to solve the question of how to improve asset management ratios.
The simplest way includes focussing on the increment of revenue for better asset management ratios. The utilization of assets might be proper but low sales would still end up in a lower ratio. As a result, sales could be increased by quick movement in finished goods and more promotions.
Unused assets or obsolete ones need to be liquidated as soon as possible. However, assets used occasionally must be analysed to look at whether they can be retained or not. Therefore, concluding the business sell those who do not add to the work regularly.
Another alternative for firms using less of assets like e-commerce customer relationship management businesses could always lease the assets rather than purchase them. This concludes that any leased asset is not counted or part of the fixed asset of the company.
As understood the inefficient use of assets may turn into low asset management ratios. Therefore, analysing how the assets are used or how to improve the asset management ratio by productivity might help. This explains that an increase in output must occur without any further increase in the expenses of the company.
The slower collection of accounts receivables turns the sales to be lower resulting in a decline in asset management ratios. As a result, the company must engage in quick collection practices. This could be carried forward by outsourcing the practice to a collection agency, reducing the paid time given to the customers and employing a person to collect pending invoices for the company.
Better inventory management
An eye on inventory management needs to be figured out to look after the movement of the goods along with the process. The cycle explains when the delivery system lacks or is behind the desired time.
The delays in the product reach to the customers lead to extending the collection time for no reason. Therefore, businesses must invest in technology to automate the billing, order and system processes. Concluding the increment in sales improves asset management turnover ratios.
Therefore, the asset management ratios explain the requirement by the stakeholders to know the performance of the company for several aspects. Relying merely on profit structure is not enough which aids by the ratios.
Therefore, they are necessary to evaluate the effectiveness and efficiency of the business. The purpose depends on the user. But they do donate significance although might include a few limitations.