The Asset Turnover Ratio: What It Is and How to Use It

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Example of the Total Asset Turnover Ratio

When calculating and analyzing asset turnover ratio for your company, be sure you only compare results to those in similar industries. When calculating net sales, you always https://www.bookstime.com/ need to take returns and adjustments into consideration. Once you have these numbers, you can use the formula to calculate the asset turnover ratio for your business.

When calculated over several years, your average asset turnover ratio can help to pinpoint business efficiency trends and spot problem areas before they become a major issue. However you use the asset turnover ratio for your business, calculating this valuable metric is important to optimize business performance. Fundamentally, in order to calculate the average total assets, what you have to do is simply add the beginning and ending total asset balances together and divide the result by two. While there is always the option of utilizing a more in-depth, weighted average calculation, this isn’t mandatory. The asset turnover ratio is one of the ratios that measure the efficiency of a company by finding the amount of revenue generated from its assets. Asset turnover ratio measures the value of a company’s sales or revenues generated relative to the value of its assets. The asset turnover ratio is used to evaluate how efficiently a company is using its assets to drive sales.

How to Know if a Company Is a Worthwhile Investment

As with all financial ratios, a closer look is necessary to understand the company-specific factors that can impact the ratio. And such ratios should be viewed as indicators of internal or competitive advantages (e.g., management asset management) rather than being interpreted at face value without further inquiry. Let us take a practical example of companies operating in the petrochemicals industry for whom asset turnover ratio is important as they have to invest a large amount in capital expenditure. Sally’s Tech Company is a tech start up company that manufactures a new tablet computer. Sally is currently looking for new investors and has a meeting with an angel investor. The investor wants to know how well Sally uses her assets to produce sales, so he asks for her financial statements. The asset turnover ratio is most useful when compared across similar companies.

Now we know the definition of asset turnover, let’s take a look at an illustrative example. For this reason, you should always make a point of comparing your results with other companies in the same industry. Generally speaking, a higher ratio is a more desirable outcome for most businesses.

Step 3. Perform the calculation

Look for a higher current asset turnover ratio because it shows that a company is strong in its fundamentals. Look at the current asset turnover ratio because they are interested in the performance of the company in terms of net sales. Of net sales, it is considered a benchmark of the quality of the company’s sales. As expected, low margin companies would have higher asset turnover ratios since they have to offset lower profits with higher sales. Similarly, for highly capital-intensive industries such as petrochemicals, utilities, power, etc. the asset turnover ratios will be lower since their assets will be much higher.

Conversely, if the ratio is lower it indicates that the company is not using its assets efficiently. There are various reasons for which the asset turnover ratio may be lower for a company. Some of the reasons are poor inventory management and collection methods or due to excess production capacity. Like with most ratios, the asset turnover ratio is based on industry standards.

To get a true sense of how well a company’s assets are being used, it must be compared to other companies in its industry. The total asset turnover ratio calculates net sales as a percentage of assets to show how many sales are generated from each dollar of company assets. For instance, a ratio of .5 means that each dollar of assets generates 50 cents of sales. An asset turnover ratio equal to one means the net sales of a company for a specific period are equal to the average assets for that period. The company generates $1 of sales for every dollar the firm carried in assets. It is the gross sales from a specific period less returns, allowances, or discounts taken by customers. When comparing the asset turnover ratio between companies, ensure the net sales calculations are being pulled from the same period.

The current assets turnover ratio is a signal for the future of the company that is measured in present terms. It provides a view into the sales figures that, in turn, can show the profitability or performance of the company in the market. Like most other financial ratios, the current assets turnover ratio is a comparative ratio that needs to be calculated in conjunction with other forms of ratios.

What Is Net Asset Turnover?

To be more precise, the total asset turnover ratio calculates net sales as a given percentage of assets, in an attempt to outline how many sales are generated from each asset owned by the company. As an example, in the case of a .5 ratio, every dollar of the asset would facilitate no less than 50 cents of sales. The fixed asset turnover ratio is similar to the tangible asset ratio, which does not include the net cost of intangible assets in the denominator. The fixed asset turnover ratio is most useful in a “heavy industry,” such as automobile manufacturing, where a large capital investment is required in order to do business. In other industries, such as software development, the fixed asset investment is so meager that the ratio is not of much use. A business that has net sales of $10,000,000 and total assets of $5,000,000 has a total asset turnover ratio of 2.0.