The operating assets ratio can be used as part of an analysis to eliminate those company assets that are not contributing to operations. For example, if a rival company has a low operating assets ratio, a competitor could use the rival's ratio as the basis for an internal review to see how many assets should be eliminated in order to arrive at a similar ratio. The result of these actions would be a reduced investment in assets, with the terminated assets being converted into cash.
To derive the operating assets ratio, divide the total amount of non-cash assets listed on the balance sheet by the book value of all assets used to generate revenues. Both accounts receivable and inventory should be included in the calculation. The formula is:
Assets used to generate revenues ÷ Total non-cash assets
For example, Clyde Shotguns is now in its fourth generation of company ownership, and the latest Clyde president wants to conduct a house cleaning of assets. The CFO of the company assembles the following information:
|Asset Type||Gross Value|
|Current Accounts Receivable||$850,000|
|Overdue Accounts Receivable||60,000|
|Furniture & Fixtures||95,000|
|Unused Production Equipment||160,000|
The resulting operating assets ratio is:
($850,000 Accounts receivable + $225,000 inventory + $95,000 fixtures + $2,000,000 equipment) ÷ $3,425,000 Total assets
= $3,170,000 Assets used to generate revenue ÷ $3,425,000 Total assets
= 92.6% Operating assets ratio
The analysis reveals that the company can potentially reduce $255,000 of its assets, though there are likely to always be some overdue accounts receivable.
There are several issues to be aware of when using the operating assets ratio:
- Which assets are not considered to assist in generating revenues is a subjective decision, since some assets could be considered reserve capacity.
- Some assets, such as overdue receivables, are simply a part of doing business, and are unlikely to be eliminated on an ongoing basis.
Consequently, consider writing a detailed procedure for how this metric is to be calculated, and in which each asset type is defined, with examples.