Question

3. Asset management ratios

Asset management ratios are used to measure how effectively a firm manages its assets, by relating the amount a firm has invested in a particular type of asset (or group of assets) to the amount of revenues the asset is generating. Examples of asset management ratios include the average collection period (also called the days sales outstanding ratio), the inventory turnover ratio, the fixed asset turnover ratio, and the total asset turnover ratio.

Consider the following case:

Adams Furniture has a quick ratio of 2.00x, $37,575 in cash, $20,875 in accounts receivable, some inventory, total current assets of $83,500, and total current liabilities of $29,225. The company reported annual sales of $100,000 in the most recent annual report.

Over the past year, how often did Adams Furniture sell and replace its inventory?

-2.86x

-4.39x

-3.99x

-8.01x

The inventory turnover ratio across companies in the furniture industry is 4.389x. Based on this information, which of the following statements is true for Adams Furniture?

-Adams Furniture is holding more inventory per dollar of sales compared with the industry average.

-Adams Furniture is holding less inventory per dollar of sales compared with the industry average.

You are analyzing two companies that manufacture electronic toys—Like Games Inc. and Our Play Inc. Like Games was launched eight years ago, whereas Our Play is a relatively new company that has been in operation for only the past two years. However, both companies have an equal market share with sales of $100,000 each. You’ve collected company data to compare Like Games and Our Play. Last year, the average sales for all industry competitors was $255,000. As an analyst, you want to make comments on the expected performance of these two companies in the coming year. You’ve collected data from the companies’ financial statements. This information is listed as follows: (Note: Assume there are 365 days in a year.)

Data Collected (in dollars)

	Like Games	Our Play	Industry Average
Accounts receivable	2,700	3,900	3,850
Net fixed assets	55,000	80,000	216,750
Total assets	95,000	125,000	234,600

Using this information, complete the following statements to include in your analysis.

1.	A ____days of sales outstanding represents an efficient credit and collection policy. Between the two companies,____is collecting cash from its customers faster than____ , but both companies are collecting their receivables less quickly than the industry average.
2.	Our Play’s fixed assets turnover ratio is____ than that of Like Games. This could be because Our Play is a relatively new company, so the acquisition cost of its fixed assets is ____than the recorded cost of Like Games’s net fixed assets.
3.	Like Games’s total assets turnover ratio is____ , which is_____than the industry’s average total assets turnover ratio. In general, a higher total assets turnover ratio indicates greater efficiency.

Answer 1

Answer a.

Current assets = Cash + Accounts receivable + Inventory
$83,500 = $37,575 + $20,875 + Inventory
Inventory = $25,050

Inventory turnover = Sales / Inventory
Inventory turnover = $100,000 / $25,050
Inventory turnover = 3.99 x

Answer b.

Adams Furniture is holding more inventory per dollar of sales compared to the industry average.

Answer c.

Like Games:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $2,700 / $100,000
Days of sales outstanding = 9.86 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $100,000 / $55,000
Fixed assets turnover = 1.82 times

Total assets turnover = Sales / Total assets
Total assets turnover = $100,000 / $95,000
Total assets turnover = 1.05 times

Our Play:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $3,900 / $100,000
Days of sales outstanding = 14.24 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $100,000 / $80,000
Fixed assets turnover = 1.25 times

Total assets turnover = Sales / Total assets
Total assets turnover = $100,000 / $125,000
Total assets turnover = 0.80 times

Industry Average:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $3,850 / $255,000
Days of sales outstanding = 5.51 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $255,000 / $216,750
Fixed assets turnover = 1.18 times

Total assets turnover = Sales / Total assets
Total assets turnover = $255,000 / $234,600
Total assets turnover = 1.09 times

A low days sales outstanding represents an efficient credit and collection policy. Between the two companies, Like Games Inc. is collecting cash from its customers faster than Our Play Inc., but both companies are collecting their receivables less quickly than the industry average.

Our Play’s fixed-asset turnover ratio is lower than that of Like Games. This could be because Our Play is a relatively new company, so the acquisition costs of its fixed assets is higher than the recorded cost of Like Games’s net fixed assets.

Like Games’s total asset turnover ratio is 1.05, which is lower than the industry’s average total asset turnover ratio. In general, a higher total asset turnover ratio indicates greater efficiency.