Operating assets ratio is designed for use by managers to determine which assets can be safely eliminated from a company without impairing its operational capabilities. Its intent is to focus management attention on assets that are not generating a return on investment so that they can be eliminated. Obviously, this ratio is based solely on information in the balance sheet.
Divide the dollar value of all assets used in the revenue creation process by the total amount of assets. Both of these numbers should be recorded at their gross values, prior to any depreciation deduction. The calculation can also include accounts receivable and inventory. The formula is:
Assets used to create revenue
Operating Assets Ratio Example
Lie Dharma Motor Company has been in business since 1925 and has accumulated a large number of fixed and other assets during that time. The company has recently been acquired by a much younger company that wants to “clean up shop”, partially by reviewing all assets and clearing out those that are no longer needed. As a first step in this process, its acquisition team elects to calculate the operating assets ratio and then use the results to target individual assets for further action. It accumulates the information found in the following table:
Current accounts receivable $ 428,000
Overdue accounts receivable $ 33,000
Current inventory $ 978,000
Obsolete inventory $ 524,000
Furniture and fixtures $ 207,000
Production equipment $4,832,000
Unused production equipment $1,403,000
Total assets $8,405,000
The acquisition team elects to exclude overdue accounts receivable, obsolete inventory, and unused production equipment from the numerator in the equation, thereby focusing attention on those items as logical targets for reduction in order to make matrix a more asset-efficient organization. The resulting calculation is:
$428,000 Accounts receivable + $978,000
Inventory+ $207,000 Fixtures + $4,832,000 Equipment
$8,405,000 Total assets
$6,445,000 Assets used to create revenue
$8,405,000 Total assets
= 76.7% Operating assets ratio
The measurement reveals that about one quarter of Lie Dharma’s assets cannot be usefully employed for revenue generation and should be evaluated for elimination.
Issues On The Operating Assets Ratio and How To Minimize Them
The derivation of the asset list used for the numerator is highly subjective. Unless the measurement is backed up with a rigorous selection system to determine which assets are truly being used for productive activities, it is likely that some assets will be included in the numerator that should not be there. Also, the concept of asset usage to create revenue can create gray areas, for example, should any equipment used by the sales department be itemized as part of the revenue creation process? The best way to deal with these issues is to create a detailed list of what asset classes should be included in the measurement, which may also require a written justification for the inclusion of specific assets in the numerator of the formula.