Asset Management or Turnover Measures

We next turn our attention to the efficiency with which Prufrock uses its assets. The measures in this section are sometimes called asset utilization ratios. The specific ratios we discuss can all be interpreted as measures of turnover. What they are intended to describe is how efficiently or intensively a firm uses its assets to generate sales. We first look at two important current assets, inventory and receivables.

Inventory Turnover and Days' Sales ¡n Inventory During the year, Prufrock had a cost of goods sold of $1,344. Inventory at the end of the year was $422. With these numbers, inventory turnover can be calculated as:

Cost of goods sold

Inventory turnover =-

Inventory

In a sense, Prufrock sold off or turned over the entire inventory 3.2 times.4 As long as we are not running out of stock and thereby forgoing sales, the higher this ratio is, the more efficiently we are managing inventory.

4Notice that we used cost of goods sold in the top of this ratio. For some purposes, it might be more useful to use sales instead of costs. For example, if we wanted to know the amount of sales generated per dollar of inventory, then we could just replace the cost of goods sold with sales.

PART TWO Financial Statements and Long-Term Financial Planning

If we know that we turned our inventory over 3.2 times during the year, then we can immediately figure out how long it took us to turn it over on average. The result is the average days' sales in inventory:

Days' sales in inventory

365 days

Inventory turnover 365 days

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