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Asset Ratio Analysis
The ability to generate revenues and earn profits on assets can be measured through ratio analysis. Several types of ratios can be calculated regarding the utilization of assets.
Example : Asset Turnover gives an indication of how often assets are converted into sales. The Asset Turnover Ratio is calculated as follows: Sales / Average Assets. If annual sales were $ 200,000 and the average asset balance for the year was $ 160,000, the asset turnover rate would be 1.25. A higher turnover rate implies effective use of assets to generate sales.
Receivable and Inventory ratios are part of asset ratio analysis. Inventory Turnover gives an indication of how much inventory is held during the reporting period. Example: Cost of Goods Sold for the Year was $ 270,000 and the average inventory balance during the year was $ 90,000. This results in an inventory turnover rate of 3 ($ 270,000 / $ 90,000). The average number of days inventory is held is calculated as follows: 365 days in the reporting period / inventory turnover rate. In our example, this would be 122 days.
Finally, you can look at the use of capital for generating revenues. Two common ratios are Total Capital Turnover and Investment Rate. Total Capital Turnover is calculated as: Sales / Average Total Capital. Average Total Capital consists of both debt and equity. The Investment Rate is the rate of change in capital. The Investment Rate is calculated by simply dividing the amount of change in capital / total beginning capital. A high investment rate would imply an aggressive program for generating future sales.