F1 7.06 Use of Resources Ratios: Asset Turnover

In this session on Use of Resources Ratios we shall look at two Asset Turnover Ratios; the Asset Turnover (Net Assets) ratio and the Asset Turnover (Non-Current Assets) ratio.

Asset Turnover Ratios

Asset turnover ratios look at how well, or efficiently, a business uses different types of assets to generate sales revenue.

These ratios are presented as a number of times (e.g. 1.31 times). As mentioned in earlier sessions, you should show them to the number of decimal places specified in any brief or question but if this is not specified one or two decimal places is usually detailed enough for most situations.

The Asset Turnover (Net Assets) ratio looks at how a business uses both its non-current assets and working capital to generate sales.

The Asset Turnover (Non-Current Assets) ratio looks at how a business uses its non-current assets to generate sales.

The formulae to be used for both ratios are shown below.

Illustration

A company’s financial statements are shown below.

The Asset Turnover (Net Assets) ratio will use the Sales Revenue from the Statement of Profit or Loss as well as the totals of Non-Current Assets, Current Assets and Current Liabilities from the Statement of Financial Position.

Asset Turnover (Net Assets): 15,030/(12,950 + 2,780 – 1,490) = 1.06 times

The Asset Turnover (Net Assets) ratio will use the Sales Revenue from the Statement of Profit or Loss as well as the Non-Current Assets from the Statement of Financial Position.

Asset Turnover (Non-Current Assets): 15,030/12,950 = 1.16 times

Evaluating asset turnover ratios

Generally, it is good if the business’ asset turnover (of both types) is higher than its comparator and bad if it is lower. This is because a higher asset turnover ratio means the business is generating more sales revenue from its use of the assets.

If for example, a company’s asset turnover (non-current assets) ratio has changed from 1.3 times last year to 0.9 times this year, we would say that the ratio has worsened.

Asset Turnover (Net Assets) ratio: reasons for change

This ratio is affected by any changes in any of its constituent parts So we would have to consider the reasons why:

• Sales may have changed (e.g. new products, discounts offered, changes to credit terms offered)
• Non-current assets may have changed (e.g. purchases or sales of property, plant & equipment, depreciation of assets)
• Current assets may have changed (e.g. changes to inventory levels, trade receivables policies)
• Current liabilities may have changed (e.g. use of a bank overdraft, changes to the credit taken from suppliers)

Asset Turnover (Non-Current Assets) ratio: reasons for change

As was the case with the previous ratio, this is affected by any changes in any of its constituent parts So we would have to consider the reasons why:

• Sales may have changed (e.g. new products, discounts offered, changes to credit terms offered)
• Non-current assets may have changed (e.g. purchases or sales of property, plant & equipment, depreciation of assets)

Question 1

A business’ statement of profit or loss and statement of financial position are shown below