Question

Describe how a company can determine how effective it is in using its Assets to produce net income. What are some measures of asset utilization and efficiency?

Answer 1

Asset utlization can be measured by the following ratios which help in analyzing the efficiency with which the assets are being utlised.

1. Assets turnover ratio.

The Total revenue is divided by the average assets of the company which gives an indication, how fast the asstes are being used to generate sales and in turn revenues for the company. A high ratio indicates an eficient use of the assets.

2. Return on assets:

This is another ratio to evaluate the asset utlization. This is calculated by dividing the Net income of the company by average total assets., this coupeld with the first ratio gives a indication of the efficeny of the operations of the company.

3. Receivables turnover and average collection period:

Receivables turnover indicates how many times the receivables are turned into sales, and the average collection period indicates the efficiency of truning the receivables into cash.

4. Inventory turnover and average inventory age:

These ratios indicate how fast the inventory is turned into finished goods and the period for which the inventories are held before turing them into sales.