Asset Turnover Ratio
Definition
Asset turnover ratio measures a company's ability to generate sales from its total assets. It reflects how efficiently assets are used.
Example
If Company A has $400 million in revenue and average total assets of $200 million:
⁴⁰⁰⁄₂⁰⁰ = 2.0
Interpretation
- A higher ratio means efficient asset use—each dollar of assets generates more sales.
- Low ratios may indicate underutilized assets or excess capacity.
- Varies by industry: supermarkets (low margins, high volume) typically have higher ratios than utilities.
Buy/Sell Use
- Buy: Firms with rising or above-industry-average asset turnover, indicating improving efficiency.
- Sell: Firms with falling or persistently low asset turnover, especially if paired with poor profitability.
Example in Practice:
Costco and Walmart have high asset turnover, signaling effective inventory management and store productivity.
Fixed Asset Turnover
Definition
Fixed asset turnover focuses on how efficiently a company uses its property, plant, and equipment (PPE) to generate revenue.
Interpretation
- High ratio: Effective use of manufacturing plants, stores, or equipment.
- Low ratio: Possible over-investment in assets or operational inefficiency.
- Important in asset-heavy sectors: manufacturing, telecom, retail.
Buy/Sell Use
- Buy: Efficient firms, or those improving fixed asset turnover.
- Sell: Companies investing heavily in assets with no sales growth, or with deteriorating ratios.
Example in Practice:
Toyota's high fixed asset turnover shows strong global factory utilisation.
Receivables Turnover
Definition
Receivables turnover shows how quickly a company collects cash from customers (accounts receivable).
Interpretation
High ratio: Quick collection, efficient credit policy.
Low ratio: Slow collection, possible bad debts, or lenient credit terms.
Buy/Sell Use
Buy: Companies improving receivables turnover, with good cash conversion.
Sell: Firms with declining ratios, rising receivables, or frequent write-offs.
Example in Practice:
Software companies that shift to subscription (SaaS) often see rising receivables turnover, as recurring payments accelerate cash collection.
Payables Turnover
Definition
Payables turnover measures how quickly a company pays suppliers
Interpretation
- High ratio: Company pays suppliers quickly (good for supplier relations, but may miss out on credit terms).
- Low ratio: Takes longer to pay suppliers (can help conserve cash, but risks strained relationships).
Buy/Sell Use
- Buy: Stable payables turnover, especially with healthy cash flow.
- Sell: Sudden drops (paying too slowly may signal cash stress), or unusually high ratios if it harms working capital.
Example in Practice:
Large retailers often negotiate long payment terms, leading to low payables turnover and improved cash flow.
Cash Conversion Cycle (CCC)
Definition
The cash conversion cycle measures the time (in days) it takes for a company to turn investments in inventory and other resources into cash from sales.
Interpretation
- Shorter CCC is better: company gets cash back faster.
- Longer CCC: cash tied up in operations, possibly leading to liquidity issues.
Buy/Sell Use
- Buy: Companies with stable or improving CCC.
- Sell: Firms with rising CCC, as it may signal operational issues or impending cash crunch.
Example in Practice:
Dell famously optimized its CCC to negative by getting paid by customers before paying suppliers.
Days Sales Outstanding (DSO)
Definition
DSO shows the average number of days it takes to collect payment after a sale.
Interpretation
- Low DSO: Fast collection, more cash on hand.
- High DSO: Slow collection, risk of bad debts.
Buy/Sell Use
- Buy: Firms maintaining or reducing DSO.
- Sell: Rising DSO, especially without sales growth.
Days Inventory Outstanding (DIO)
Definition
DIO measures the average days inventory is held before being sold.
Interpretation
- Low DIO: Inventory sold quickly, less risk of obsolescence.
- High DIO: Slow-moving inventory, possible excess stock.
Buy/Sell Use
- Buy: Companies with stable or improving DIO.
- Sell: Firms with rising DIO, particularly in fast-changing sectors.
Days Payable Outstanding (DPO)
Definition
DPO measures the average days a company takes to pay its suppliers.
Interpretation
- High DPO: Company uses supplier credit efficiently (good for working capital).
- Too high: May strain supplier relationships.
- Low DPO: Pays quickly, possibly missing out on available credit.
Buy/Sell Use
- Buy: Companies optimizing DPO in line with industry and cash flow.
- Sell: Firms with rapidly rising DPO (potential stress) or very low DPO in cash-tight situations.
Inventory Turnover
Definition
Inventory turnover shows how many times a company’s inventory is sold and replaced during a period.
Interpretation
- High turnover: Efficient inventory management, less money tied up.
- Low turnover: Possible overstock, inefficiency, or weak demand.
Buy/Sell Use
- Buy: Companies with high or rising turnover, especially in retail and manufacturing.
- Sell: Declining turnover, risk of inventory write-downs.
Example in Practice:
Zara and other fast-fashion retailers have high inventory turnover, driving profitability and reducing markdown risk.
How Investors Use Efficiency & Asset Management Ratios
- Value Investors: Look for firms with high asset utilization, stable CCC, and efficient inventory management, especially during downturns.
- Growth Investors: Want efficiency metrics to keep pace with sales growth, not deteriorate due to expansion.
- Activist Investors: Target firms with lagging efficiency to drive operational improvements.
- Short Sellers: Focus on deteriorating efficiency as a warning sign.
Example Buy/Sell Decision:
- An investor comparing two consumer electronics firms might buy the one with higher asset turnover and a shorter cash conversion cycle, betting on better operational execution.
References
White, G. I., Sondhi, A. C., & Fried, D. (2003). The Analysis and Use of Financial Statements. Wiley.
Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
CFA Institute. (2023). CFA Level 1 Curriculum – Financial Reporting and Analysis.
Investopedia. (2024). “Efficiency Ratios” and “Asset Management Ratios.”
Yahoo Finance, Company Filings.
