Analyzing Total Assets Turnover
Total assets turnover captures how efficiently assets are being utilized to generate revenues. Higher revenues generated with a given level of assets indicates more efficient use of those assets. Exhibit 4.6 showed that PepsiCo’s total assets turnover steadily decreased from 2010 to 2012, falling from 1.07 to 0.89. The first step you might take toward understanding changes in total assets turnover is to be aware of the relative changes in the numerator (sales) and denominator (average total assets) across the years. In 2011, sales increased 15%, but this was outpaced by a 31% increase in average total assets; similarly, in 2012, average total assets increased 4.5% relative to a 1.5% decrease in sales. Thus, in both years, total assets turnover declined. A significant change across these years is the acquisition of the bottlers, PBG and PAS, and the Russian food and beverage company, WBD, which increased assets, primarily through fair value recognition of various intangible assets like goodwill and brands. These additions to assets have yet to be matched by commensurate increases in sales, leading to the overall declines in total assets turnover.
Unlike the analysis of profit margin, where we decomposed the numerator by examining different expenses that determined operating profit, the analysis of total assets turnover can best be achieved by decomposing the denominator. We can gain greater insight into changes in total assets turnover by examining turnover ratios for particular classes of assets under the logic that turnover ratios for individual assets aggregate to total assets turnover. The following three turnover ratios are among the most popular, largely driven by the importance of each of these assets
Accounts receivable turnover
Total assets turnover captures how efficiently assets are being utilized to generate revenues. Higher revenues generated with a given level of assets indicates more efficient use of those assets. Exhibit 4.6 showed that PepsiCo’s total assets turnover steadily decreased from 2010 to 2012, falling from 1.07 to 0.89. The first step you might take toward understanding changes in total assets turnover is to be aware of the relative changes in the numerator (sales) and denominator (average total assets) across the years. In 2011, sales increased 15%, but this was outpaced by a 31% increase in average total assets; similarly, in 2012, average total assets increased 4.5% relative to a 1.5% decrease in sales. Thus, in both years, total assets turnover declined. A significant change across these years is the acquisition of the bottlers, PBG and PAS, and the Russian food and beverage company, WBD, which increased assets, primarily through fair value recognition of various intangible assets like goodwill and brands. These additions to assets have yet to be matched by commensurate increases in sales, leading to the overall declines in total assets turnover.
Unlike the analysis of profit margin, where we decomposed the numerator by examining different expenses that determined operating profit, the analysis of total assets turnover can best be achieved by decomposing the denominator. We can gain greater insight into changes in total assets turnover by examining turnover ratios for particular classes of assets under the logic that turnover ratios for individual assets aggregate to total assets turnover. The following three turnover ratios are among the most popular, largely driven by the importance of each of these assets
Accounts receivable turnover
- Inventory turnover
- Fixed assets turnover
Management’s discussion and analysis of operations usually provides detailed explanations for operating profits, but it does not include explanations for changes in assets turnovers; so you must search for possible clues. This is unfortunate because small changes in assets turnover can have enormous effects on the overall profitability of a firm (that is, ROA and ROCE).
Accounts Receivable Turnover
The rate at which accounts receivable turn over indicates the average time until firms collect them in cash. You calculate accounts receivable turnover by dividing net sales on account by average accounts receivable. Most sales transactions between businesses are on account, not for cash. Except for retailers and restaurants that deal directly with consumers, the assumption that all sales are on account is usually reasonable. The calculation of the accounts receivable turnover for 2012 for PepsiCo is as follows (in millions):
Accounts Receivable Turnover
The rate at which accounts receivable turn over indicates the average time until firms collect them in cash. You calculate accounts receivable turnover by dividing net sales on account by average accounts receivable. Most sales transactions between businesses are on account, not for cash. Except for retailers and restaurants that deal directly with consumers, the assumption that all sales are on account is usually reasonable. The calculation of the accounts receivable turnover for 2012 for PepsiCo is as follows (in millions):
PepsiCo’s accounts receivable turnover was 10.0 in 2011 and 10.6 in 2010. Accounts receivable turnover is often framed in terms of the average number of days receivables are outstanding before firms collect them in cash. The calculation divides 365 days by the accounts receivable turnover.35 The average number of days that accounts receivable were outstanding was 38.8 days (365/9.4) during 2012, 36.5 days (365/10.0) during 2011, and 34.4 days (365/10.6) during 2010. One also could calculate the days’ sales included in the ending accounts receivable balance, in which case the calculation would be ending accounts receivable divided by average daily sales (sales/365). The slight increase in accounts receivable at the end of 2012 and the slight decline in sales from 2011, yields a slightly higher days’ sales in the ending receivables [$7,041/ ($65,492/365) ¼ 39.2]. These computations clearly indicate that PepsiCo is collecting accounts receivable more slowly. Many firms transact business with credit sales terms of 30 days. Although customers are paying more slowly, most of PepsiCo’s customers pay within a reasonable period of just over one month.
The interpretation of changes in the accounts receivable turnover and average collection period also relates to a firm’s credit extension policies. Firms often use credit terms as a means of stimulating sales. For example, in an effort to stimulate sales, firms might permit customers to delay making payments on purchases of lawn mowers until after the summer and on snowmobiles until after the winter. Such actions would lead to a decrease in the accounts receivable turnover and an increase in the number of days receivables are outstanding. The changes in these accounts receivable ratios would not necessarily signal negative news if the increase in net income from the additional sales exceeded the cost of carrying accounts receivable for the extra time.
The interpretation of changes in the accounts receivable turnover and average collection period also relates to a firm’s credit extension policies. Firms often use credit terms as a means of stimulating sales. For example, in an effort to stimulate sales, firms might permit customers to delay making payments on purchases of lawn mowers until after the summer and on snowmobiles until after the winter. Such actions would lead to a decrease in the accounts receivable turnover and an increase in the number of days receivables are outstanding. The changes in these accounts receivable ratios would not necessarily signal negative news if the increase in net income from the additional sales exceeded the cost of carrying accounts receivable for the extra time.
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