ASSET MANAGEMENT RATIOS
Asset management ratios are the financial statement ratios that measure how effectively a business uses and controls its assets. Below are discussed five types of asset management ratios:
 
1. Inventory turnover ratio
2. The days sales outstanding
3. Average payment period
4. Fixed asset turnover ratio
5. Total asset turnover ratio
   
1.  Inventory turnover ratio: The ratio is regarded as a test of efficiency and indicates the rapidity with which the company is able to move its merchandise.

Inventory turnover ratio = Gross Turnover / Inventories

Following table shows the Inventory Turnover ratio of Square Pharmaceuticals in different years:

Year

2005-06

2004-05

2003-04

Inventory Turnover Ratio

5.27 times

5.41 times  

6.89 times

Analysis shows a gradual declination of Inventory Turnover Ratio over the last three yeas. In 2003-04, the ratio was 6.89 times, then it rapidly declined to 5.41 times in following year and dropped further to 5.27 times in the year 2005-06.

The company’s balance sheets show increase of inventory with declining turnover every year. Declining inventory turnover commonly indicates that the company is not being able to flush its inventory very well as it was doing in the previous years. A low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort. High inventory levels are unhealthy because they represent an investment with a zero rate of return in addition to the increased cost associated with maintaining those inventories. It also opens the company up to trouble should prices begin to fall. However, in some instances a low rate may by appropriate, such as where higher inventory levels occur in anticipation of rapidly rising prices or shortages.

In order to improve Inventory Turnover ratio, at first an end-to-end view in addressing inventory needs to be looked at. Supply chains need to be optimized, production processes should have to be efficient as well, so that the suppliers become able to produce and deliver materials in a timely, low cost fashion that allows the company to minimize their inventory and cost of materials. Collaborative relationships with customers can allow them to make their demand for products more predictable thereby allowing to minimize finished product inventory without failing to meet their needs for volume and timeliness.

Discount-driven sales may generate a boost in sales. Such discounts can erode the company’s profit margins but will boost revenue and rate of inventory turnover. The company might look like it is becoming leaner, when in fact it may simply be pushing products into the marketplace using artificial low pricing. However, before it can be done, the gross margins reported by the business needs to be analyzed carefully. If gross margins decrease as a percentage of sales in spite of an increase in inventory turnover, they should not apply this policy.

Supplier-financed inventory may reduce inventories and show improved inventory turnover by forcing suppliers to carry the inventory for the company. The suppliers assume the cost of maintaining inventory and passes that cost on. Alternatively, the company may reduce inventory by the use of express shipment or other costly means of delivery to ensure the availability of materials and supplies when needed. Solutions of maintaining inventory that simply shift cost to suppliers return the cost in added mark-ups to the materials and supplies purchased. This results in a rise in unit product unit cost.


2.  The Days Sales Outstanding: The Days Sales Outstanding ratio shows both the average time it takes to turn the receivables into cash and the age, in terms of days, of a company's accounts receivable. This ratio is of particular importance to credit and collection associates.

Days Sales Outstanding (DSO) = Trade Debtors/(Annual gross turnover/365)

Following table shows the DSOs of Square Pharmaceuticals in different years:

Year

2005-06

2004-05

2003-04

DSO

14.87 days

15.75 days

14.99 days

Analysis shows that DSO was 15.75 days in 2003-04; highest among the three years. In 2003-04, it was 14.99 days and in 2005-06 it was 14.87 days; lowest among the three years.

Since the DSO was the highest in 2004-05 that indicates that customers were taking longer times to pay their bills, which may be a warning that customers were dissatisfied with the company's product or service, or that salespeople were making sales to customers that are less credit-worthy, or that salespeople have to offer longer payment terms in order to seal the deal. Long credit policy might be used deliberately to boost sales temporarily. Of course, it could also mean that the company has an inefficient or overtaxed accounts receivables department. However, the significant improvement in 2005-06 signifies that the company collected its outstanding receivables quicker than the previous years and that the credit terms are getting more realistic. It also connotes that the company had greater control over quality of its customer relationship management (CRM) during the following year.

3. Average payment period: The accounts payable turnover ratio includes all outstanding obligations that a company owes its creditors.

Average Payment Period (APP) = Payables / (Cost of goods sold/365)

Following table shows the APPs of Square Pharmaceuticals in different years:

Year

2005-06

2004-05

2003-04

APP

234.07 days

225.27 days

161.25 days

Analysis shows a gradual increase of company’s average payment period. In 2003-04, the average payment period was 161.25 days, and then it became 225.27 days and 234.07 days consecutively for the following two years.

The underlying reason for the ratio to go up is the significant increase of company’s debt; especially short and long term bank loans (which made the current portion of long-term loans high). Each year this amount is getting higher than the previous years. Furthermore, in 2004-05 there was a huge sum trade credits unpaid. All these played key role for the payables to increase. A long payment period at first improves the company's liquidity, but my also be an indicator for liquidity problems. Therefore, it is important to keep the value equal or close to the average value. Since the company’s payment period is getting longer, i.e. the company pays too late, then it means the liquidity problem of the company. The company probably lacks of the money to pay its liability. Hence, questions may arise on the company's credit worthiness and paying habits. It has long been recognized that late payment of business debt is a serious problem for suppliers of goods and services. Late Payment can make it necessary for a company to increase borrowing and to extend overdraft facilities.  Time and resources can be taken up on maintaining and collecting late payments instead of being devoted to other areas of business.

4. Fixed asset turnover ratio: The Fixed Asset Turnover ratio measures the effectiveness in generating Net Sales revenue from investments in Net Property, Plant, and Equipment back into the company evaluates only the investments. 

Fixed assets turnover ratio (FATO) = Gross Turnover / Net fixed assets

Following table shows the FATO ratios of Square Pharmaceuticals in different years:

Year

2005-06

2004-05

2003-04

FATO

1.35 times

1.33 times

1.42 times


Analysis shows that the fixed asset turnover ratio was as high as 1.42 times among three years. However, it declined to 1.33 times in the following year. In 2005-06 the turnover somewhat increased to 1.35 times.   

The rapid declination of turnover in 2004-05 occurred because sales did not keep pace with the increase of company’s fixed assets. Company’s capital work-in-progress increased substantially in the year 2005-06. 2004-05 capital work-in-progress was also higher then the previous year. It may happen if the company was not being able to utilize its assets efficiently. However, conclusions should not be drawn solely on the numerical results of this ratio. A careful study on the balance sheet shows that large amount of investments were made during that year that inflate the dollar volume of fixed assets, and give an impression of mismanagement. The case is applicable for the 2005-06 as well. The turnover was highest in 2003-04 only because no significant investments were made during that period and the capital work-in-progress was lowest amongst the three years. Therefore, enough evidence is not available from this ratio analysis whether the company is really performing inefficiently or it is the investments that pulled down the turnover. Perhaps total asset turnover ratio can tell more about what really went wrong.

5. Total asset turnover ratio: The Total Asset Turnover is similar to fixed asset turnover since both measures a company's effectiveness in generating sales revenue from investments back into the company. Total Asset Turnover evaluates the efficiency of managing all of the company's assets.

Total assets turnover ratio (TATO) = Gross Turnover/Total Assets

Following table shows the TATO ratios of Square Pharmaceuticals in different years:

Year

2005-06

2004-05

2003-04

TATO

0.76 times

0.78 times

0.93 times


Analysis shows a gradual fall of company’s total asset turnover. In 2003-04, it was 0.93 times, declined to 0.78 times in the following year and then again declined slightly to 0.76% in 2005-06.

It may be an indicator of company’s pricing strategy as company with high profit margins tends to have low asset turnover. It is in fact might be one of the reasons for why the assets turnover was low in the year 2004-05. Profit margin went up from 17.69% in 2003-04 to 20.25% in the next year. However, there are other reasons as well. In 2004-05 total assets increased by 25.68% while sales increased by only 11.57%. Other than investment in marketable securities, every other asset especially long-term investments, inventories, short-term loans and cash balance had gone up substantially. Same is the case for the year 2006-06 as sales could not keep up with assets. Long-term investment, capital work-in-progress, inventories, short-term loan was also high during this year. On the other hand, the profit margin was only 16.45%. So it could be concluded than higher profit margin may not be the actual reason for the turnover to go down. Perhaps the company is not utilizing its assets efficiently.