What’s an asset ratio?
It’s a ratio that 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 un-necessarily 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
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.
Pros of buying / cons of leasing
- Increasing your sales with the same assets. When you 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 less 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. Reaching out to your accountant for the best tax strategy is a good starting point.
- Aim to free up cash flow. 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.
At Meridian, we’re big on small business. Learn about our small business banking solutions and how we can help if you’re thinking of investing in real estate.
Talk to one of our Small Business Advisors. They’ll take the time to get to know you and your business, and can help tailor financial solutions that fit your needs.