Here is a variation on the receivables collection period. How long, on average, does it take for Prufrock Corporation to pay its bills? To answer, we need to calculate the accounts payable turnover rate using cost of goods sold. We will assume that Prufrock purchases everything on credit.
Page 64The cost of goods sold is $1,344, and accounts payable are $344. The turnover is therefore $1,344/$344 = 3.9 times. So, payables turned over about every 365/3.9 = 94 days. On average, then, Prufrock takes 94 days to pay. As a potential creditor, we might take note of this fact.
Asset Turnover Ratios Moving away from specific accounts like inventory or receivables, we can consider several “big picture” ratios. For example, NWC turnover is:
This ratio measures how much “work” we get out of our working capital. Once again, assuming we aren’t missing out on sales, a high value is preferred. (Why?)
Similarly, fixed asset turnover is:
With this ratio, it probably makes more sense to say that for every dollar in fixed assets, Prufrock generated $.80 in sales.
Our final asset management ratio, the total asset turnover, comes up quite a bit. We will see it later in this chapter and in the next chapter. As the name suggests, the total asset turnover is:
In other words, for every dollar in assets, Prufrock generated $.64 in sales.
To give an example of fixed and total asset turnover, based on recent financial statements, Southwest Airlines had a total asset turnover of .88, compared to 1.50 for IBM. However, the much higher investment in fixed assets in an airline is reflected in Southwest’s fixed asset turnover of 1.17, compared to IBM’s 4.41.
EXAMPLE 3.3 More Turnover
Suppose you find that a particular company generates $.40 in sales for every dollar in total assets. How often does this company turn over its total assets?
The total asset turnover here is .40 times per year. It takes 1/.40 = 2.5 years to turn total assets over completely.