Question

Which of the following scenarios would be better for an investor? and WHY?

1. Negative profit margin ratio with high asset turnover.

OR

2. Negative profit margin ratio with low asset turnover.

Answer 1

Asset turnover ratio = total sales / average asset .

By this equation we can understand what asset turnover ratio is. The asset turnover ratio used for measuring the value of a company's sales or revenues compared to the value of its assets. otherwise it can be referred as the efficiency of the company to convert its asset to make revenue or sales. The higher asset turnover ratio shows that company is more efficient at making revenue from its assets. Like same lower asset turnover indicate that the company cannot make revenue increased by its assets. It is the ratio for revenue or sales to average asset. Investors can use these asset turnover ratio for the comparison purpose. There are companies with diffrent asset turnover and profit margin. So by analysing the asset turnover ratio investors can make comparison of the company from same industry. We can only compare same industry or companies which are performing similiar because diffrent industries use its assets in different manner and purpose. So by ATR we can compare similiar type companies.

profit margin ratio = net profit / total sales or revenue

profit margin ratio indicates that how much profit company make as compared to the total sales or revenue of the company. Here by looking into it we can understand that how the company control its cost for making profit and strategies adapted by the company is good or bad.

HERE 2 Scenarios are given. we can closely scrutnize these two cases then we can identify which would be better for investor.

1. Negative profit margin ratio with high asset turnover

companies with negative profit margin and higher asset turnover indicates that the company has to face a challenge for increasing its return on asset. Because low profit margin shows low return for the company but at the same time higher asset turnover indicates that company is making higher revenue from its assets. This shows that how much a company can earn from its assets. in this case they need to increase their return on asset because negative profit margin shows negative ROA but still the company is efficient. Here even though the profit margin is less the company can improve because its sales are more by using its assets. So it can be considered as an efficient company which tend to improvise their performance.

2.Negative profit margin ratio with low asset turnover.

Here the investors will not opt this type of companies because we can here see that the asset turnover and profit margin of the company is low. So it means company has low return on asset and the efficiency of the company to make sales or revenue from its assets are very less. so these type of companies can be concluded as less efficient companies. Investing in this type of companies contain more risk because low turnover companies can not generate higher profit and sales volume also. so the sales and profit will be low.

by analysing the two scenarios we can understand that the first case which the company having negative profit margin but higher asset turnover ratio will be more safe and profitable for investing.