Financial Definitions: Asset Turnover Ratios

Financial Definitions: Asset Turnover Ratios

As we continue our definitions series with an in-depth look at the terms on stock balance sheets, we come to the definitions that comprise the asset turnover ratios. These include receivables turnover, inventory turnover, fixed assets turnover, and the average collection period. This long list of definitions may seem intimidating, but the asset turnover ratio definitions aren't so bad. Let's take a closer look at them.

Asset Turnover Ratios

Let's dive right in to the general definition of the asset turnover ratios. Basically, the ratios that measure the asset turnover determine how well sales and assets are managed, or how efficient the company is as a whole.

Receivables Turnover Ratio

To determine the company's efficiency, the many ratios listed above are tested. The first we'll look at is the receivables turnover ratio. This ratio measures how well a company conducts itself in its accounts receivables department, where it both extends short-term credit to customers and collects on monies owed. If everything in this department is flowing smoothly, the receivables turnover ratio will be high. If there are issues in how quickly the company collects their payments, the ratio will be low. For investors, a high ratio is desirable.

Inventory Turnover Ratio

The next ratio is the inventory turnover ratio. This ratio measures how well the company handles inventory. Because both not holding enough inventory for sales and holding too much inventory can cause inefficiencies, the aim of this ratio is balance. For that reason, when comparing the inventory turnover ratio to similar companies, the goal is to see a mid-grade ratio (neither excessively high nor low).

Fixed Assets Turnover Ratio

As we move along, we come to the fixed assets turnover ratio, which measures how well the company uses its equipment and its plant. If the company is not using one or the other efficiently, the fixed assets turnover will be low. A high ratio is therefore more desirable to the investor.

Average Collection Period Ratio

This ratio is almost an extension of the receivables turnover ratio. It determines how many days it takes the company to collect on the credit it extended to its customers. This ratio should be low, showing that the company collects quickly.

All of these ratios together make up the total asset turnover ratio. If any of the ratios are undesirable, the total asset turnover ratio will reflect the issue through a low number. However, if everything's running smoothly within the company, the total asset ratio will be high.

That's it for the asset turnover ratios. Now, as you read stock balance sheets, you'll be equipped with the knowledge needed to make more informed stock decisions Stay tuned as we define more stock terms in the future!

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Jana's picture

Jana wrote:

Tue, 01/31/2012 - 14:20 Comment #: 1

Thank you for these definitions! This is one area of personal finance where I am severely deficient and posts like this help me so much.

Christa Palm's picture

Christa Palm wrote:

Thu, 02/02/2012 - 22:05 Comment #: 2

Jana, I'm glad you enjoy them!