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Asset Utilization or Efficiency Ratios

Businesses prime motive is to earn profits for its owners. In companies shareholders are owners and they

elect management of the company so that management earns profits for the benefit of owners of businesses. When owners elect management they give them the control of the company’s assets for the purpose of generating profits using these assets. These assets can be tangible (e.g. property, plant & equipment) or intangible (e.g. goodwill). As a result management becomes responsible for using these assets in the most efficient way for generating profits. This section will cover the ratios which are used to obtain information about the efficiency with which management has used company’s assets.

Asset Utilization / Efficiency ratios are linked with

  • Working Capital (Current Assets – Current Liabilities): the ratios which determine and calculates the efficiency with which management has used its working capital i.e. its current assets and current liabilities.

  • ROCE: As we already discussed, changes in ROCE can be studied using margin and asset utilization ratios. Here we will see the asset utilization i.e. total (Fixed as well as current) assets efficiency.

Types of Asset Utilization / Efficiency Ratios

To check the performance of the company that how efficiently they have generated profits, following ratios are used.

  • Debtors’ Turnover
  • Total Assets Turnover

Following pages will explain the listed above ratios using the written below method:

FORMULA

First question comes in mind is HOW TO CALCULATE THE PARTICULAR RATIO? I will write down the most common formula used for calculating a ratio along with alternative, if any.

EXAMPLE

With example I will calculate the ratio using the formula given above. PLEASE NOTE THAT, in examples I will use data from HYPOTHETICAL FINANCIAL STATEMENTS (as given here)so that you can calculate ratios from real financial statements in you practical life.

MEASUREMENT UNIT

In which unit the ratio is measured i.e. in currency unit (dollars), percentages, days or whatever.

INTERPRETATION

After calculating the ratio, the next logical question that comes in mind is WHAT DOES THIS RATIO MEAN? So I will teach

  • How to interpret the ratio; and
  • What particular user needs this ratio addresses. (You must have an understanding of users’ needs of financial statements; please refer the topic 1- financial statement users for details).

 

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