Financial ratios indicate relationships between different financial statement items. Management can use these ratios to evaluate a company's performance over time or against industry averages. Asset management ratios measure a company's success in generating sales through prudent management of its assets, such as accounts receivable, inventory and fixed assets. The balance sheet summarizes a company's assets, while the income statement shows sales, expenses and profits.
Calculate the receivables turnover ratio, which is the ratio of credit sales to accounts receivable. Credit sales refer to purchases that you invoice and the customer pays later. This ratio measures a company's ability to collect its outstanding receivable accounts. A high ratio means that receivables are low relative to sales, which could mean that customers are paying their invoices promptly.
Compute the inventory turnover ratio, which is the ratio of cost of goods sold to inventory. A high ratio could mean that the company is converting its inventory into sales faster. Do not compare the inventory turnover ratios of companies with different methods of calculating the cost of goods sold.
Determine the average collection period, also known as the days' receivables ratio or the days' sales outstanding. It is 365 divided by the receivables turnover ratio. It indicates the average length of time to collect on overdue accounts. For example, if the receivables turnover ratio is six, the days' receivables are about 61 days (365/6). If the company's credit terms require full payment in 45 days, it means that the company is on average 16 days (61 - 45) behind on its account collections.
Determine the days' sales in inventory, also known as the days' inventory ratio. It is equal to 365 divided by the inventory turnover ratio. It indicates how many days an inventory item stays in stock before a sale. For example, if the inventory turnover ratio is 10, the days' inventory ratio is about 37 days (365/10).
Compute the fixed asset turnover ratio, which is the ratio of sales to the book value of fixed assets. It measures a company's effectiveness in generating sales from its fixed assets. Companies normally depreciate the cost of a fixed asset, such as plant and equipment, over its useful life. The book value is equal to the acquisition cost minus the accumulated depreciation. For example, if sales are $10,000 and the book value of fixed assets is $8,000, the fixed asset turnover ratio is 1.25 ($10,000/$8,000).
Calculate the total asset turnover ratio, which is the ratio of sales to total assets. This is a broad measure of the company's ability to generate sales from its total assets, which include both current and fixed assets.