This ratio measures the effectiveness of the firm’s use of assets to generate sales revenue. This ratio can vary over time for a given firm. Firms in the start-up stage tend to have low asset turnover ratios, while mature companies tend to have a more stable asset turnover. Generally, a high asset turnover ratio indicates that the assets are being effectively employed; however, a high asset turnover does not explicitly take into account that the firm might be using old assets, which have been fully depreciated. A firm using newly purchased assets will show a lower turnover ratio because of the higher depreciation costs even though the new machinery is highly efficient. Firms will try to keep their long-term asset turnover ratios close to the industry norm.

Inventory Turnover

The inventory turnover ratio indicates the number of times that an inventory is sold and replaced over a given time period. This ratio can be used to assess the quality of an inventory. Inventory turnover ratios vary widely by industry and obvious deviations from the industry standard may indicate problems. Too much inventory can indicate improper purchasing, inadequate marketing, or an undesirable product. On the other hand, too little inventory can cause problems with product availability and can therefore hurt sales.

Receivable Turnover

The receivable turnover ratio measures the effectiveness of a firm’s credit and collection policies. A high receivable turnover rate can indicate an effective credit and collection policy or alternatively it can indicate that a business operates on a cash basis. A low turnover rate indicates that the firm should pay more attention to collecting its accounts receivable. Accounts Receivable can amount to interest free loans to customers. The firm should analyze its accounts receivable in terms of its stated credit policy.