Asset Turnover

The asset turnover ratio is a way to measure the value of a company’s sales compared to the value of the company’s assets. It’s an efficiency ratio that lets you see how efficiently the company uses its assets to generate revenue.

The asset turnover ratio is expressed as a number instead of a percentage so that it can easily be used to compare companies in the same industry. So, for example, if a company had an asset turnover ratio of 3, this means that each dollar of assets generates $3 of revenue.

This means that the higher the asset turnover ratio, the more efficient the company is. If the company has a low asset turnover ratio this indicates they are not used assets efficiently to generate sales.

Asset Turnover Ratio Formula

$$Asset\: Turnover\: Ratio = \dfrac{Net\: Sales}{Average\:Total\:Assets}$$

To calculate the asset turnover ratio for a company, divide the net sales by its average total assets.

The formula uses net sales from the company income statement, which means that product refunds, sales discounts and sales allowances must be deducted from total sales to measure the true ratio.

To work out the average total assets you add the value of the assets at the beginning of the year to the value of assets at the end of the year and divide the result by two.

This simple two-year balance sheet is average, but some companies prefer to use the more in-depth weighted average calculation which assigns average costs to each piece of inventory sold in a given year.

Asset Turnover Ratio Example

Brandon’s Bread Company has been in the confectionery business for years. The company wants to expand its operations, and they have been looking for an angel investor. They have a meeting with one this year who has requested to know how well Brandon’s utilizes the company assets to produce sales.

The following information was extracted from Brandon’s income statement for the year that ended in July 2019:

  • Beginning assets: $70,000
  • Ending Assets: $120,000
  • Net Sales: $25,000

You can calculate Brandon’s Company total assets turnover ratio by dividing its net sales by average total sales.

$$Average\: Total\: Assets = \dfrac{\$70{,}000 + \$120{,}000 }{2} = \$95{,}000$$

$$Asset\: Turnover\: Ratio = \dfrac{\$25{,}000}{\$95{,}000} = 0.26$$

A ratio of 0.26 means that Brandon’s generates 26 cents for every dollar worth of assets. This low asset turnover ratio could mean that the company is not utilizing its assets to full potential which is a risk factor for an investor.

Asset Turnover Ratio Analysis

Companies calculate this ratio on an annual basis, and higher asset turnover ratios are preferred by investors and creditors compared to lower ones. 

If a company has an asset turnover ratio of 5 it would mean that each $1 of assets is generating $5 worth of revenue. This is favorable because it is a sign that the company is using its assets efficiently.

It’s important to note that the asset turnover ratio is based on industry standards and some industries are likely to have better ratios than others. So to really be able to use the asset turnover ratio effectively it needs to be compared to other companies in the same industry.

Asset intensive industries like airports, rail, mining etc will have a lower ratio because they have more value in their assets which will lower the ratio.

On the opposite side, some industries like finance and digital will have very few assets, and their asset turnover ratio will be much higher.

The ratio can be used as part of a broader analysis of a company, but it does have its limitations:

  • It only provides meaningful analysis in asset-heavy industries and isn’t very useful in service-based industries or those with few assets
  • Some companies will outsource assets, which reduces the asset base and gives a higher ratio
  • Companies can sell off assets in preparation for a decline in growth to artificially inflate the ratio

Asset Turnover Ratio Conclusion

The Asset Turnover Ratio provides a comparison between the net sales and the average assets of a business or company with a higher ratio implying utilization of the company assets in production and vice versa.  The following points are a recap of the entire article.

  • Asset turnover ratio measures how well a company will be able to combine all its assets to produce sales or revenues in a given year
  • The efficiency ratio compares a company’s net sales with average total sales.
  • Asset turnover ratio is expressed as a numeric and not as a percentage.
  • Using this ratio to compare companies in the same industry will be preferable than comparing companies across industries.
  • Assets intensive industries will register a higher ratio than brain driven service industries.
  • Higher asset turnover ratio is favorable as it is an indication that a company is making good use of its assets.
  • A low asset turnover ratio indicates inefficiency in production.
  • The ratio provides insights to creditors as well as investors on the wellbeing of a company.

Asset Turnover Ratio Calculator

You can use the asset turnover ratio calculator below to work out your own ratios for comparison with other companies in your industry.

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