The asset turnover ratio is a measure of a company’s efficiency in using assets to generate sales. It’s calculated as net sales divided by average total assets in a specific accounting period. A higher ratio indicates better efficiency, while a lower ratio suggests less effective use of assets. Like other ratios, the asset turnover ratio is highly industry-specific. Sectors like retail and food & beverage have high ratios, while sectors like real estate have lower ratios. The asset turnover ratio can be modified to analyze only the fixed assets of a company.
Key Takeaways
- The asset turnover ratio measures how efficiently a company uses its assets to generate sales.
- A higher asset turnover ratio suggests a company is more effective in converting assets into revenue.
- Compare asset turnover ratios within the same sector, as ratios vary significantly between industries.
- The ratio is calculated by dividing net sales by average total assets for a specific period.
- Analyzing changes in the asset turnover ratio over time can indicate improvements or declines in operational efficiency.
How to Calculate the Asset Turnover Ratio
The asset turnover ratio compares performance from the income statement with the company’s financial health on the balance sheet. The formula is:
Asset Turnover Ratio = Net Sales / Average Total Assets
Net sales is the total amount of revenue retained by a company. 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.
Average total assets are found by taking the average of the beginning and ending assets of the period being analyzed. The standard asset turnover ratio considers all asset classes including current assets, long-term assets, and other assets.
Fixed vs. Total Assets
A common variation of the asset turnover ratio is the fixed asset turnover ratio. Instead of dividing net sales by total assets, the fixed asset turnover divides net sales by only fixed assets. This variation isolates how efficiently a company is using its capital expenditures, machinery, and heavy equipment to generate revenue. The fixed asset turnover ratio focuses on the long-term outlook of a company as it focuses on how well long-term investments in operations are performing.
The asset turnover ratio is expressed as a rational number that may be a whole number or may include a decimal. By dividing the number of days in the year by the asset turnover ratio, an investor can determine how many days it takes for the company to convert all of its assets into revenue.
Asset Turnover Ratio in Practice: An Example
Suppose company ABC had total revenues of $10 billion at the end of its fiscal year. Its total assets were $3 billion at the beginning of the fiscal year and $5 billion at the end. Assuming the company had no returns for the year, its net sales for the year were $10 billion. The company’s average total assets for the year was $4 billion (($3 billion + $5 billion) / 2 ).
ABC Company’s Asset Turnover Ratio = $10 billion / $4 billion = 2.5
On the other hand, company XYZ, a competitor of ABC in the same sector, had a total revenue of $8 billion at the end of the same fiscal year. Its total assets were $1 billion at the beginning of the year and $2 billion at the end.
XYZ Company’s Asset Turnover Ratio = $8 billion / $1.5 billion = 5.33
Though ABC has generated more revenue for the year, XYZ is more efficient in using its assets to generate income as its asset turnover ratio is higher. XYZ has generated almost the same amount of income with over half the resources as ABC.
Understanding the Implications of Asset Turnover Ratios
The asset turnover ratio is most useful when compared across similar companies. Due to the varying nature of different industries, it is most valuable when compared across companies within the same sector.
The asset turnover ratio can also be analyzed by tracking the ratio for a single company over time. As the company grows, the asset turnover ratio measures how efficiently the company is expanding over time; especially compared to the rest of the market. Although a company’s total revenue may be increasing, the asset turnover ratio can identify whether that company is becoming more or less efficient at using its assets effectively to generate profits.
Companies can artificially inflate their asset turnover ratio by selling off assets. This improves the company’s asset turnover ratio in the short term as revenue (the numerator) increases as the company’s assets (the denominator) decrease. However, the company then has fewer resources to generate sales in the future. The asset turnover ratio calculation can be modified to omit these uncommon revenue occurrences.
Low vs. High Asset Turnover Ratios
The asset turnover ratio will vary from sector to sector. Publicly-facing industries including retail and restaurants rely heavily on converting assets to inventory, then converting inventory to sales. Other sectors like real estate often take long periods of time to convert inventory into revenue. Though real estate transactions may result in high profit margins, the industry-wide asset turnover ratio is low.
A key component of DuPont analysis is the asset turnover ratio. A system that began being used during the 1920s to evaluate divisional performance across a corporation, DuPont analysis calculates a company’s return on equity (ROE). It breaks down ROE into three components, one of which is asset turnover.
What Is a Good Asset Turnover Ratio?
Asset turnover ratio results that are higher indicate a company is better at moving products to generate revenue. As each industry has its own characteristics, favorable asset turnover ratio calculations will vary from sector to sector.
What Does an Asset Turnover of 1 Mean?
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 carries in assets.
How Is Asset Turnover Ratio Used?
The asset turnover ratio is used to evaluate how efficiently a company is using its assets to drive sales. It can be used to compare how a company is performing compared to its competitors, the rest of the industry, or its past performance.
The Bottom Line
The asset turnover ratio helps investors understand how efficiently companies are using their assets to generate sales. It’s calculated by dividing net sales or revenue by the average total assets. A high ratio can mean that companies are successful at converting assets into revenue. Bear in mind that different industries and sectors can have different ratio levels. So, for example, a lower ratio may be acceptable in certain cases. Therefore, investors should compare ratios for companies in the same sector or group to determine which is getting the most value from its assets.
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