Agriculture Reference
In-Depth Information
Asset turnover ratio
:
net sales divided by total assets
. The asset turnover ratio can be used
to determine the intensity with which BF&G's assets are used, as measured by the
number of times assets “turn over” in a period:
(12)
/
$, ,
Net Sales
Total Assets
=
Asset Turnover
21
From Income Statement a Balance Sheet s
13 41
0 000
/$,
6 677
,
00000
.
,;
=
(
)
,
This fi gure shows that BF&G turned its assets about two times during the year. For this
ratio to take on meaning, BF&G managers would have to compare it with the situation
in previous years and to the turnover ratio in similar businesses. If last year's turnover
ratio had been only 1.8, BF&G would know that it has improved asset utilization. A
retail grocer would be very unhappy with this ratio because of the necessity for rapid
turnover in that kind of business, while an agricultural producer would be extremely
happy with this ratio, since production agriculture tends to use a huge amount of assets
relative to sales.
The asset turnover ratio (Equation 12) suggests that the more BF&G can sell with a
given set of assets, the higher its return on investment. Many large agribusiness fi rms
use this as a primary measure of effectiveness or effi ciency of the management team.
Management strategies that affect this ratio are primarily focused on increasing sales
volume, using assets more effectively, increasing prices, reducing ineffectively used
assets, reducing accounts receivable or inventory, or choosing better alternatives for use
of available cash.
Inventory turnover ratio
:
cost of goods sold divided by ending inventory
. Another similar,
yet more specifi c measure of effi ciency is focused on inventory. In most fi rms, the
inventory turnover ratio is of great concern. A signifi cant portion of a fi rm's assets may
be tied up in inventory:
Cost of Goods Sold
/
Ending Inventory
=
Inventory Turnover Rat
io
(13)
$,
11 725 2 5 4 69
From Income Statement b Ba
,
000
/$,
00 000 =
,
.
,;
(
)
lance Sheet e
,
An inventory turnover ratio of 4.7 means BF&G was able to sell its inventory 4.7 times
during the course of the previous year. In a different view, BF&G was able to generate
$ 4.69 in sales for every $1 invested in inventory.
Here, caution must be used, since the measure of inventory must be meaningful. This is
a static reading that is taken. In BF&G, with an extremely seasonal business, the ending
inventory is not representative, and could provide a meaningless fi gure. The manager
may need to average beginning and ending inventory; he or she may also take monthly
or estimated average inventories to arrive at an acceptable fi gure. In a fi rm like BF&G,
the typical monthly average would probably be a more valid fi gure to use in an analysis
of inventory effi ciency. When comparing the fi rm's sales level and inventory level, the
correct fi gures must be used. In most cases, fi rms value inventory on an “at cost” basis.
Thus, the cost of goods sold fi gure must be used as an indicator of sales activity.
