Asset management ratios are designed to measure a business’s ability to use assets. They help understand whether the business has been able to efficiently utilize the assets and generate revenue/earnings for its investors and other stakeholders.

In other words, it’s a measure of a business’s capacity for utilizing assets and generating revenue/earnings for its stakeholders. So, if the business efficiently utilizes its assets, a higher return is expected, and vice versa.

The asset turnover ratio is a prime example of an asset management ratio.

1-Asset turnover ratio formula

Asset turnover ratio = Net sales / Total assets implied in the business

Interpretation of ratio

 Higher asset turnover reflects the business’s efficient utilization of assets. In other words, the business has been using its assets at optimum capacity and generating optimized returns for its stakeholders.

On the other hand, a low asset turnover ratio reflects a business that has been inefficient in utilizing its assets at full capacity. So, it’s like an opportunity loss for the business stakeholders, and improved asset use can be a working direction to enhance revenue and overall profitability.

Another example of an asset management ratio is a receivable turnover ratio.

2-Receivable turnover ratio

The receivable turnover ratio helps understand whether the business has efficiently collected debtor balances in the context of credit sales. This ratio indicates how often a business can turn its accounts receivable into cash over a specific accounting period.

The receivable turnover ratio formula

Receivable turnover ratio = Net credit sales / Average accounts receivable

Interpretation of ratio

A higher receivable turnover ratio indicates that the business has been efficiently collecting receivables from customers, which is a good sign. However, a lower turnover ratio reflects that the business has been inefficient in collecting its receivable balance. So, the business may find it challenging to manage cash needs.

However, appropriate benchmarking needs to be set before interpretation. This benchmarking can be established using industrial norms, competition analysis, trend analysis, seasonal analysis, or business targets.

3-Inventory turnover ratio

The inventory turnover ratio indicates the business’s capacity to manage its inventory. This ratio reflects the number of times the business sold total inventory within the specified accounting period.

If inventory sales have been frequent (in $ terms), the ratio is expected to be higher and vice versa. On the other hand, lower inventory turnover indicates pile-up and higher inventory closing.

The inventory turnover ratio formula

Inventory turnover ratio = Cost of goods sold / Average inventory

Cost of sales is the Cost of inventory purchased/produced. It’s recorded in the profit and loss statement while making sales.

Average inventory calculates inventory held by a business throughout the accounting period under consideration.

Interpretation of ratio

If the inventory turnover ratio is higher, it indicates optimized and fast inventory movement from warehouse to customer. It helps understand if the business has been successful in selling inventory at a faster pace. On the other hand, a lower value depicts the business’s inability to ensure frequent sales, which may be an area of improvement.

However, there is no absolute benchmark to assess whether the ratio has increased or decreased. So, analysis must consider seasonal variation, trend analysis, contextual analysis, market trends, industrial practices, business nature, etc.

Conclusion

Asset management ratios helps measure business efficiency in managing its assets. Effective management generates higher revenue/profit and vice versa. So, if the business effectively manages its assets, the ratio is expected to be higher, and vice versa.

The asset turnover ratio indicates whether the business has been utilizing its assets at optimum capacity. Asset utilization is about generating revenue/profit. Higher asset turnover means the business has been efficient, and vice versa.

The receivable turnover ratio reflects whether the business has been efficiently collecting its receivable management function.

The inventory turnover ratio is about a business’s ability to generate sales using its average inventory.