How asset turnover ratios can help you improve your productivity
Read time: 3 minutes
Whether you’re buying equipment or stocking up on inventory, every dollar you put into your business should deliver a return by generating revenue or helping you improve your profits. Asset utilization ratios can be very helpful to assess how well you’re doing when compared to your peers.
According to BDC Business Consultant Jorge Henao, each ratio provides you with a different perspective, but depending on what type of business you operate one ratio could be more helpful than the other. For instance, if you operate in a capital intensive environment, the fixed asset turnover will help you determine how much your fixed assets (e.g. machinery and equipment) are contributing to your business productivity. On the other hand, if you operate in a service environment the total asset turnover might be more helpful as the investment in fixed asset won’t necessarily be as important as the inventory and/or the receivables.
Asset turnover ratio
The asset turnover ratio indicates how much your business is generating in revenues for every dollar invested in total assets. Thus, if your business has revenues of $100,000 and total assets of $50,000, the asset utilization ratio will be 2:1. That means your operations generate $2 in revenues for every $1 you have in assets.
Fixed asset turnover ratio
The fixed asset turnover ratio indicates how much your business is generating in revenues for every dollar invested in fixed assets. Thus, if your business has revenues of $100,000 and net fixed assets of $25,000, the asset utilization ratio will be 4:1. That means your operations generate $4 in revenues for every $1 you have in net fixed assets.
Henao offers the following tips for entrepreneurs who want to use asset turnover ratios in their business.
1. Know your benchmarks.
A good asset turnover depends on the type of environment you operate in and the size of the business. So you need to find out what the asset turnover is for a business of your size in a similar industry.
2. Understand why your ratios are above/below the industry benchmark.
If your fixed asset turnover is well above the industry benchmark it doesn’t necessarily mean that your capital productivity is higher, this could be explained by old depreciated assets that break down very often or that require a lot of manual intervention. Similarly, if your fixed asset turnover if well below the industry benchmark it could be explained by an important investment you’ve made recently in new machines that are to provide you with higher revenues in the near future.
3. Look at other indicators.
The asset turnover ratios are helpful in terms of capital productivity. But measuring labour productivity is equally important.
“You can have the best, fastest, most high-volume piece of equipment installed on your shop floor, but if you’re only using it at 25% capacity because you don’t have enough revenues or you have inefficiencies that require that your employees do a lot of manual work you’re still not getting full value out of it.” Henao says
Get help when you need it
Financial ratios like asset turnover can give you powerful insights into how your business is performing. They can also be a little complex or intimidating at first, especially if you don’t know what to look for or how to interpret them. Henao says it’s always a good idea to get some expert help if you feel you need it.
With the right information, you can make smart decisions to fine-tune your operations and improve your profitability.