Asset Turnover Summary

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Asset Turnover

1. Introduction

Asset turnover assesses how effectively a company uses the assets it has under its

control

It does this by relating sales levels to the level of assets used to generate them: Asset

Turnover = Sales/Net Assets.

On a general basis, companies will aim to: Maximise the level of total sales by setting the

most effective marketing mix; Minimise the level of net assets (in terms of the individual

components that make it up).

As with analysing Profit Margins, the different components that influence Asset Turnover

can be represented in a flowchart

From a managerial perspective, working capital is the element of Net Assets that can be

controlled most effectively on a day-to-day basis.

The majority of working capital consists of three items from the Balance Sheet – stock,

debtors and creditors.

The level of each of these components is usually related to the volume of business a

company is engaged in.

Working capital levels can be assessed by working out the value of the ratio of each

element (e.g. stock, debtors or creditors) in relation to sales. This is normally expressed in

terms of a defined period of time (in days).

The stock (holding) ratio can be formulated in one of two ways (driven by conventions

within the industry in question, and/or the preferences of those conducting the analysis):

No. of days for which stock is held; Frequency with which stock is ‘turned over’.

Stock days are calculated by dividing stock by sales, and then multiplying the result by

360.

The stock holding ratio strips out the effect of the level of sales in any particular year,

making it easier to compare a company’s stock holding over time.

In situations where analysts can access cost of sales data (or the value of stock at selling

price), the ratio can be further refined in its comparison of stock to volume.

Please note: a stock ratio figure is a ‘snapshot’ of a particular point in time, and may be

atypical when compared to other times of year for a business (for example, as seasonal

factors may affect them).

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Debtor days = (Debtors/Sales) x 360. For most businesses, using the debtors ratio is

preferable to the stock ratio because both sales and debtors are valued in terms of the

selling price. (However, this does not apply in cases where a large percentage of sales

are made for cash).

Please note: As with using the stock ratio, seasonal factors may undermine the

representativeness of the debtor ratio value – as may the one-off impact of a large

customer payment being made.

Creditor days = (Creditors/Sales) x 360. The creditors ratio has a similar limitation to the

stock ratio in that it does not give an absolute measure, as creditors are not valued at

selling price.

When used for internal purposes, it is preferable to utilise purchases instead of sales (and

to isolate trade creditors).

An alternative approach for assessing creditor levels is to compare them to the level of

stock at the same point in time, expressing the result as a percentage: (Creditors/Stock) x

100.

2. Fixed Asset Turnover

As well as being driven by working capital, the level of asset turnover is also determined

by a company’s fixed assets.

In the long-term, the level of fixed assets within a company can be controlled by the

managers of a business – so analysing levels of fixed asset investment compared to

sales results in another key analysis ratio: fixed asset turnover (Fixed Asset Turnover).

The ‘ratio’ version of Fixed Asset Turnover = Sales / Fixed Assets. A business will want

this to have a high value as the higher the value of the ratio is, the greater the level of

sales that are being produced for the capital that has been invested in the business.

The ‘percentage’ version of Fixed Asset Turnover = Fixed Assets / Sales. Management

would want the value of this ratio to be low. The reason for this is that the lower the value

of the ratio is, the less capital the business is needing to invest to produce a particular

level of sales.

If a business wants to improve its fixed asset ratio by either reducing it in its ‘percentage’

form, or increasing it in its ‘ratio’ form, it has two options: Option 1: produce more sales for

a given level of investment. Option 2: cut the level of fixed assets that the company needs

in order to generate sales at a given level.

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Over the long-term, depreciating fixed assets will cancel-out over the lifetime of the asset:

it is merely an accounting device.

In terms of affecting profits for a single year, selling off fixed assets raises the risk of a

divergence between book value and sale price for the asset concerned – which would hit

the P&L for the year concerned.

Approaches for improving Fixed Asset Turnover must always be assessed to clarify

whether they will increase costs. For example, additional sales may raise marketing

expenses.

Such an increase could potentially cut profits – so here, analysing the potential impact by

using the profit margin and ROCE ratios will help to clarify the net impact on the overall

profitability of the business.

3. Industry analysis: Gulf2Go & SkyTrain An average business will have an asset turnover of between 1 and 10. However, there

are many exceptions – for a small baker’s shop it may be 30 or more, and for an aircraft

company it could be as low as 1.

Manufacturing aircraft is a necessarily slow process – which means that asset turnover

for such a company will be approximately 2.5 (in comparison to the average of 12 for a

business in the supermarket industry).

Companies often determine appropriate stock levels in terms of how many ‘days of sales’

they have in stock.

However, it is more accurate to measure stock in terms of cost of sales – this is because

products are usually sold at a mark-up, and purchase price is more closely related to

stock than the selling price is. So on a practical level, cost of sales is often used as the

measure, rather than purchases.

As with stock levels, creditors should be assessed in terms of purchases, as they relate to

money a business owes for the goods they have bought to either use in manufacturing, or

for resale.

Goods that will not be re-sold are also normally included i.e. furniture for company offices.

Squeezing suppliers as hard as possible may seem tempting, but could eventually result

in a loss of discounts. If this happens, cost of sales will be impacted – and profit margins

will be hit. Companies may also end up receiving worse service from suppliers due to loss

of goodwill.

This means that decisions about how to manage creditors must also assess the potential

impact on profit margins and relationships with suppliers over the long-term.

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All businesses require fixed assets to function, but (assuming they are owned) they

increase both the value of assets and the amount of capital a business needs.

Depreciating these fixed assets will also impact profits.

In situations where they are not owned by the business, the value of both net assets and

capital may be less – but expenses (e.g. leasing costs) may be higher, which will hit

profits.

4. Improving asset turnover

Consider the following issues to utilise fixed assets more effectively:

Are capital projects authorised in a controlled manner, using cost benefit analysis? Are

they re-evaluated against projected volumes as these change?

Is a clear choice made re purchasing vs. hiring/leasing?

Is preventative maintenance used to prevent downtime?

Can assets that are not required be sold/traded?

Are assets replaced once they become unproductive?

Is surplus space rented out?

To ensure stock is being managed as effectively as possible, consider the following:

Are all orders checked to assess whether stocks are being minimised?

Could consignment agreements be reached where stock is paid for only when

consumed/sold?

Are stocks reduced with production/sales volumes?

Could stock types/lines be reduced?

Could production be better planned to reduce required stock, spare parts etc (e.g. with

Just-In-Time methods)?

Is it possible to identify (and eliminate) excess, obsolete or unsalable stocks?

In order to more effectively manage the debtors element of working capital:

Do processes exist to ensure all shipments are invoiced and credit notes are authorised?

Is it possible to reduce the credit terms on offer (e.g. through offering cash discounts?)

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Is credit limited to slow payers?

Is it possible to fund staff expenses using credit cards?

Can collection be speeded-up (e.g. via charging penalties or through personal contacts?)

Can queries/outstanding matters be swiftly resolved to facilitate swift payment?

Are settlement terms offered to debtors prior to legal action?

Are miscellaneous debtors (e.g. staff loans) reviewed on a regular basis?

Can staff loans be financed in an alternative way?

In terms of managing creditors:

Is credit taken on the best available terms?

Are goods received always checked to ensure they meet specification?

Are incentives such as cash discounts analysed in terms of cost benefit analysis?

Is it possible to delay payments for services such as insurance?

If overseas suppliers are engaged, are they applying for export finance – and passing on

the benefits? Are arrangements in place to hedge any currency exposures?

Might it be possible to defer some benefits (e.g. bonuses) to year-end?

Are competitive quotes obtained from a range of suppliers?

Is it possible to change monthly payments to annual payments (in arrears?)

When it comes to leasing:

Could arrangements for leasing potentially finance sales?

What advantages could there be in entering into leasing contracts?

Can some book debts be sold (with or without recourse?)

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TDLP Finance for Non-Financial Managers

Financial for Non-Financial

is suitable for managers, Managers

prospective managers, and anyone else within

an organisation involved in making business

decisions. It provides a practical and interactive

introduction to understanding finance in

business. The course clearly explains and

demonstrates the principles underlying the

recording of financial data. It shows how the key financial statements are analysed. And it

demonstrates how the information they contain is used to construct the financial ratios vital to making

business decisions - including the key ratios used to measure past and (projected) future business

performance.

Who is it for?

Managers, prospective managers, and anyone else within an organisation involved in making

business decisions.

Course aims

To give learners a thorough, practical

understanding of the basics concerning the

structure and use of the key financial statements

and financial analysis ratios. This will empower

them to analyse – and potentially improve – the

financial performance of their own business.

Asset Turnover Summary

Asset Turnover 7

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Objectives

Explain the function and purpose of the three key financial statements.

Describe the structure and use of the P&L account/Income Statement.

Explain how a Balance Sheet is used and formatted.

Demonstrate how to calculate and manage a company’s Cash Flows.

Explain how companies analyse their cost structures.

Describe how businesses can use the information in their Financial Statements to gain

insights into key performance areas.

Compare and describe the key investment evaluation concepts and models.

Demonstrate the potential uses of the Profit Margin, Asset Turnover and Return On Capital

Employed (ROCE/RONA) ratios.

Duration

10 – 12 Hours

Delivery

A fully integrated and interactive digital learning course. Delivered online through the TDLP Academy

LMS or via your own corporate LMS.

Contact us

Visit our website at for further information or speak to us directly for details http://www.tdlp.org

on pricing and licence terms on , or email +44 (0)20 8743 8130 . info@tdlp.org