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What are Asset Turnover Ratios, What do They Mean, and How are They Calculated?

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Question: What are Asset Turnover Ratios, What do They Mean, and How are They Calculated?
Answer:

Asset turnover ratios, also called efficiency ratios, measure the efficiency with which a company's assets generate sales. Asset turnover ratios include the inventory turnover ratio, receivables turnover ratio, average collection period, fixed assets turnover ratio, and total assets turnover ratio.

Each of these asset turnover ratios measure the effect of that particular asset on sales. For example, if the inventory turnover ratio is too low, then the firm is holding obsolete inventory and sales are too slow.

The receivables turnover ratio measures the effect of the collection of accounts receivables on sales. A high receivables turnover ratio is generally a good thing. A low receivables turnover is an indication that there is a problem with the company's credit or collection policy and that accounts receivable are being collected too slowly.The receivables turnover ratio works hand in hand with the average collection period ratio. The average collection period measures the number of days, on average, it takes the company to collect its credit accounts. If the receivables turnover ratio is low, generally the average collection period is also low, which means the firm is efficient in collecting its credit accounts.

The fixed asset turnover ratio measures the efficiency with which the company generates sales with its plant and equipment. This ratio is particularly important in capital intensive companies. If a company is, for example, a manufacturing company, then the fixed asset turnover ratio needs to be high. The company should be operating at capacity and fully utilizing its plant and equipment in its operations. If the fixed asset turnover ratio is too low, then the company is not using its fixed assets to capacity.

The total asset turnover ratio shows the results of all the asset turnover ratios above. If there is a problem with any of the above asset turnover ratios, the problem will also show up in the total asset turnover ratio. If the total asset ratio is high, then the company is using its assets efficiently to generate sales. If the total asset ratio is too low, then the company is not using its asset base efficiently and effectively enough to generate adequate sales.

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