Asset Management Ratios (Efficiency Ratios)

 

In this article, we discuss Asset Management Ratios. Asset Management Ratios also call as Efficiency Ratios. These ratios are one type category of financial ratios.

What are the asset management ratios?

Asset management ratios measure how well companies utilize their assets to generate income. The management uses these ratios to help improve the profitability of the company. Also, outside investors and creditors look at the profitability of the company’s operations by using these ratios.

What are the types of Asset management ratios?

• Average Collection Period
• Inventory Turnover Ratio
• Cash Conversion Cycle
• Fixed Asset Turnover Ratio
• Total Assets Turnover Ratio
• Working Capital Turnover Ratio
• Receivable Turnover Ratio
• Payable Turnover Ratio

Average Collection Period

The average collection period indicates the average number of days elapsed between a credit sale and the date the company receives the payment from the credit sale.

The formula of the average collection period:

A short average collection period suggests a tight credit policy and effective management of accounts receivable. A long average collection period indicates that the company should tighten its credit policy and improve the management of accounts receivable.

Inventory Turnover Ratio

The inventory turnover ratio shows how effectively inventory is managed by comparing the cost of goods sold with the average inventory for a period. This measures how many times the average inventory is turned or sold during a period. Higher revenue with less working capital is a more desirable feature to investors.

The formula of the inventory turnover ratio:

If larger amounts of inventory are purchased during the year, the company will have to sell greater amounts of inventory to improve its turnover. This measurement shows how easily a company can turn its inventory into cash.

Cash Conversion Cycle

The cash conversion cycle uses to measure the time it takes a company to convert its investment in inventory and other resource inputs into cash. It measures how long cash is tied up in inventory before the inventory is sold and cash is collected from customers.

The formula of the cash conversion cycle:

A smaller or shorter cash conversion cycle is almost always good. A small conversion cycle means that a company’s money is tied up in inventory for less time.

Fixed Asset Turnover Ratio

The fixed asset turnover ratio measures a company’s return on its investment in property, plant, and equipment by comparing net sales with fixed assets. Investors and creditors use this formula to understand how well the company is utilizing its fixed asset to generate sales. Higher fixed asset turnover is more favorable to the company

The formula of the fixed asset turnover ratio:

Fixed Asset Turnover Ratio

The fixed asset turnover ratio measures a company’s return on its investment in property, plant, and equipment by comparing net sales with fixed assets. Investors and creditors use this formula to understand how well the company is utilizing its fixed asset to generate sales. Higher fixed asset turnover is more favorable to the company.

The formula of the fixed asset turnover ratio:

Working Capital Turnover Ratio

This ratio uses to understand how effectively the company utilizes its implied working capital to produce revenue. According to the investor’s perspective, a higher value of working capital is desirable due to it indicates enhanced efficiency.

The formula of the working capital turnover ratio:

Receivable Turnover Ratio

This ratio uses to assess the efficiency of the collection function. Here, a higher value of the receivable turnover ratio aids to understand that the business has quality customers that pay their debt on time. Also, a lower receivable turnover ratio shows inefficient funds collection, the inadequacy of credit policy, and problems with the financial status of the customers.

The formula of the receivable turnover ratio:

Payable Turnover Ratio

The payable turnover ratio uses to assess the performance of the business in terms of working capital management. However, this is not related directly to the asset management ratio. A higher value of payable turnover ratio indicates that the business is successfully managing the cash flow. A lower ratio indicates that the company takes greater time to pay off its obligations.

Additionally, stakeholders of the business can identify that the business is efficiently managing its suppliers through this ratio.

The formula of the payable turnover ratio: