An asset ratio compares your assets to another part of your business. So, you could be comparing assets to revenue, profit, the number of employees or their salaries – whichever you wanted to measure. For example, if your assets/salaries ratio increases, you may have staff over-ordering on equipment.
It’s a great ratio to assess the viability of a business. It’s also a good way to learn if you’re spending money unnecessarily on assets that aren’t helping increase your profits, and therefore don’t warrant the investment.
In short: the lower the ratio, the harder your assets are working.
Lowering the ratio
So, there are ways to measure how profitable your business is, such as a net profit margin. But an asset ratio tells you how well you’re using what you already own, so you can generate profits.
Increasing your sales with the same assets
What you’re looking to do here is get your assets working harder so that they’re contributing to your profits, rather than detracting from them.
Consider who’s buying the assets. If it’s not you, take a look at who on your staff is doing the purchasing. It’s quite common – and understandable – for an employee to order the latest technology, software, desks or vehicles which see your assets creep up, but your sales and profits don’t. If this is happening in your business, sit your employee down and have a chat about what the business needs and what it doesn’t. Teach them what an asset ratio is so that they make calculated and educated purchases in future.
If you do buy assets, make sure the ratio increases – there’s no point adding a $1m piece of machinery and end up making less profit for the year. You’d be better off not buying it and not doing the work (within reason; often you may need new equipment to remain competitive, or it has long-term implications to improve capability for new work down the track).
Maintain or increase sales with fewer assets
- Do you need all your assets? – Conduct a thorough review of all your assets and of each one, ask yourself: are they helping to generate a profit? Or are they just sitting there, and could be sold instead? Any un-used machinery or equipment could be sold to generate cash for your working capital.
- Would you be better off leasing assets? – Consider this: you could sell off some assets and then lease them back only when you need them. That way you’re reducing your assets but still making a profit.
Why is it important?
The short answer is that the purpose of any business is to generate profit, and if your assets aren’t helping you do that, you’re compromising your ability to make money. So it’s important to get a handle on your asset ratio and make sure you’re not buying or retaining assets you don’t need.
The more cash you’ve got flowing through your business, the better. If you can free up cash by selling unwanted assets, you’re going to add to your working capital and finance future growth.
In general, a low ratio indicates that the company is making good use of its existing assets. A high ratio is an indicator either of low sales or that the business has over-invested in land or equipment that isn’t benefiting the bottom line. If your asset review indicates a high ratio, it’s time to take a long hard look at your asset inventory and decide what stays and what can be converted into cash.