Asset Turnover Ratio Explained

Investors and business-owners use these tools to judge the strengths of companies as well as the areas where they may be lacking. Financial ratios take statistics gained from income reports and balance sheets and make ratios which are useful for comparing similar companies to each other. One of the ways in which companies are judged in terms of efficiency of turning assets into sales is through the net asset turnover ratio. Among the more important considerations for investors when evaluating a company is how efficiently it utilizes its assets to produce revenue. These companies have greater potential to grow and compound their earnings over time.

https://www.bookstime.com/ is a great way to measure your company’s ability to use assets to generate sales. Check out our asset turnover definition and learn how to calculate total asset turnover ratio, right here. This ratio measures how efficiently a firm uses its assets to generate sales, so a higher ratio is always more favorable. Higher turnover ratios mean the company is using its assets more efficiently. Lower ratios mean that the company isn’t using its assets efficiently and most likely have management or production problems. The asset turnover ratio is calculated by dividing net sales by average total assets.

Overview: What is the asset turnover ratio?

The asset turnover ratio measures is an efficiency ratio that measures how profitably a company uses its assets to produce sales. The asset turnover ratio measures the value of a company’s sales or revenuesrelative to the value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue. Conversely, telecommunications and utility companies have large asset bases that turn over more slowly compared to their sales volume. So, comparing the asset turnover ratio between a retail company and a telecommunication company would not be meaningful. However, looking at the ratios of two telecommunication companies would be a productive comparison. The asset turnover ratio is concerned with how efficiently a company is using its assets to generate sales.

• It does not necessarily indicate a good sign because it may not raise its capacity for future growth opportunities.
• Like with most ratios, the asset turnover ratio is based on industry standards.
• This ratio can be used by investors or analysts to evaluate whether or not businesses are effectively making use of their assets to produce revenue.
• When calculating the inventory turnover ratio, you are dividing a company’s cost of goods sold by its average inventory.
• The asset turnover ratio is a good measure of a company’s overall efficiency, while the inventory turnover ratio is a good measure of a company’s inventory management.
• For example, retail or service sector companies have relatively small asset bases combined with high sales volume.

Retail and consumer staples, for example, have relatively small asset bases but have high sales volume—thus, they have the highest average asset turnover ratio. Conversely, firms in sectors such as utilities and real estate have large asset bases and low asset turnover. The higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets.

What is the total asset turnover ratio?

Comparing the ratios of companies in different industries is not appropriate, as industries vary in capital intensiveness. Therefore, for every dollar in total assets, Company A generated $1.5565 in sales.

The fixed asset ratio is generally not very consistent, because even if the revenue is growing consistently, the fixed assets don’t have a smooth pattern. A low asset turnover ratio indicates inefficiency, or high capital-intensive nature of the business. To calculate the ratio in Year 1, we’ll divide Year 1 sales ($300m) by the average between the Year 0 and Year 1 total asset balances ($145m and $156m). We now have all of the required inputs, so we’ll take the net sales for the current period and divide it by the average asset balance of the prior and current periods. Companies with fewer assets on their balance sheet (e.g., software companies) will typically have higher ratios than companies with business models that require significant spending on assets. As with all financial ratios, a closer look is necessary to understand the company-specific factors that can impact the ratio.

Interpreting the Ratio

While that’s simple enough, the results provided by the asset turnover ratio can provide an insight into your business operations that can directly affect future decision-making. The asset turnover ratio is an accounting ratio that measures the ability of your business to use its assets to generate revenue.

You can also consider inventory and asset types you’re currently carrying on the books and see if there are ways to better utilize them, or even dispose of them. StockMaster is here to help you understand investing and personal finance, so you can learn how to invest, start a business, and make money online. In our hypothetical scenario, the company has net sales of $250m, which is anticipated to increase by $50m each year. Thus, a sustainable balance must be struck between being efficient while also spending enough to be at the forefront of any new industry shifts. On the flip side, a turnover ratio far exceeding the industry norm could be an indication that the company should be spending more and might be falling behind in terms of development. All companies should strive to maximize the benefits received from their assets on hand, which tends to coincide with the objective of minimizing any operating waste. Regardless of whether the total or fixed ratio is used, the metric does not say much by itself without a point of reference.

Definition of Total Asset Turnover Ratio

Net asset turnover is a financial measurement which is intended to gauge how well a company turns its assets into revenue. It is generally calculated as a ratio by dividing a company’s total sales revenue in a certain time period by the total value of its assets during that same period. A company with a high net asset turnover ratio is usually doing an efficient job of turning its capital into revenue.

• In contrast, businesses that have lower asset turnover ratios are not proficient at using their assets to produce revenue.
• The company wants to expand its operations, and they have been looking for an angel investor.
• Lastly, it’s important to compare the ratio to competitors in the industry to determine a baseline before making a final analysis.
• Dominion Energy has an asset turnover ratio of .03, which is not unusual for utility companies as they often have asset turnover ratios of less than one.
• Sales of $994,000 divided by average total assets of $1,894,000 comes to 52.5%.

Conversely, a lower ratio indicates the company is not using its assets as efficiently. This might be due to excess production capacity, poor collection methods, or poor inventory management. It is only appropriate to compare the asset turnover ratio of companies operating in the same industry.

Asset Turnover Ratio Example

Since anything above one is considered good, Christine’s startup is using its assets efficiently. When calculating net sales, you always need to take returns and adjustments into consideration. For the sake of completing the ratio, let’s say that your net sales for the year was $128,000, which you’ll use when asset turnover ratio calculating the asset turnover ratio. Net sales are listed on your income statement and are your total revenues less your returns, allowances, and any discounts you may have provided. Average assets is simply an average of total assets during the year based on a standard 2-year comparable balance sheet.

• However, looking at the ratios of two telecommunication companies would be a productive comparison.
• The DuPont analysis is a framework for analyzing fundamental performance popularized by the DuPont Corporation.
• Below are the steps as well as the formula for calculating the asset turnover ratio.
• She calls a meeting and tells the analysts they will calculate financial ratios and analyze the results.
• Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.
• Even with accounting software, you’ll likely calculate the ratio separately, since very few small business accounting programs can create accounting ratios.