What to Do
Asset utilization is expressed in a series of ratios (also known as activity ratios), each of which examines a different aspect of the sales/assets relationship. The combination of ratios used may vary, depending on the context, but commonly include those that also stand alone—like accounts receivable turnover and asset turnover.
Typically, a series of asset utilization ratios will include:
Average collection period
Also known as “days’ sales outstanding,” this ratio compares accounts receivable with sales per day. The result is expressed in days—the fewer the better—using the following formula:
So, if accounts receivable are $500,000 and average daily sales are 16,000, then:
Inventory turnover
This measures the cost of goods sold (COGS) against inventory. The result is expressed in “turns,” and the higher the number, the better. The formula is:
If COGS is $2 million, and inventory at the year end is $400,000, then:
Asset utilization may also include other ratios, like “debtor days,” or any of the following relationships:
- Depreciation / Assets: assesses how rapidly assets deteriorate, expressed as a percentage (a lower percentage is desirable).
- Depreciation / Sales: measures the percentage of sales needed to cover wear and tear of assets (again, a lower figure is better).
- Income / Assets: how effectively management utilizes its assets to create net income. A higher result is better; the formula is the same as that used to calculate return on assets.
- Income / Plant: similar to income / assets, except in relation to fixed assets (again, a low number could indicate problems).
- Plant / Assets: shows the proportion of an organization’s assets tied up in longer-term resources like plant, equipment and land.
What You Need to Know
- For organizations thinking about development or capital investment, an analysis of asset utilization can be particularly timely—indeed, if the efficiency of existing assets can be maximized, the need to expand or invest might be reduced or avoided altogether.
- As with all such calculations, asset utilization ratios become more meaningful over an extended period, rather than taking a single snapshot for analysis.
- Computers have reduced the time and effort needed to calculate all these sales / assets relationships, and regular asset utilization can help businesses to keep track of their performance.
Where to Learn More
Web Site:
Powerinvestor.com: www.powerinvestor.com
