Defining Asset Strength vs. Asset Utilization
"What is the difference between asset strength and asset utilization?"
A question we're commonly asked during our teaching is what are asset strength and asset utilization? These two are commonly mixed up or misidentified (even by financial professionals!!), so don't feel bad if you don't understand them - YET.
Asset Strength is the financial ability of a company to meet its debts and obligations, to make investments, and to withstand market down-turns or other business problems that may occur. Usually analyzed in relation to the company’s liquidity, the ratio of its debt to its assets, and its ability to generate cash flow.
Asset Utilization is how effectively and efficiently a company uses its assets to generate revenue and decrease costs; the productivity gained from using an asset; the return on assets (ROA) received from using an asset. Measures include inventory turnover, cycle time, and return on investment.
So, what does this even mean?
In much simpler terms, asset strength is having things like property, cash, and equipment, and asset utilization is taking those assets and getting a return on them. In other words, how efficiently are you using your assets?
An example given in the video below is how to use $100,000. You could do a few things.
1. Put it all in the market and get about a 1% return. - You will have maximum financial strength with the ability to liquidate it quickly.
2. Buy a townhome with the cash, and rent it out. Getting about a 12% return. - This will give you high utilization but low financial strength.
3. Put some money in the market, and buy a townhome with the rest of the 100k. - Giving you high financial strength and high financial utilization.
Which one would you choose?
It definitely depends on what you’re looking for. However, this third option is a much more balanced approach. It spreads your eggs a little wider so they aren’t all tied up in one basket. You would still be getting a high return on the rental, and still have liquidity while putting money in the market. A great balance between asset strength and asset utilization.
We’re essentially looking to get a higher return on the asset, than what we bought it for. If the asset is extremely volatile, there’s a high likelihood we’ll lose money on the asset. Some companies have sold office buildings that they owned and then leased them back, because the money that was tied up in the real estate, could make them more money elsewhere. Just remember: the best use of assets is growing beyond competitors to access new markets, create unimagined products, and solve a problem never solved before. If you can forecast accurately, making adjustments now can save or even make money for the company in the future.