The asset turnover ratio measures how efficiently a company uses its assets to generate revenue or sales. The ratio compares the dollar amount of sales or revenue to the company’s total assets to measure the efficiency of the company’s operations.
A higher ratio is generally preferred because it implies the business is more efficient at generating sales or revenue. A lower ratio indicates that a company may not be using its assets as efficiently. Asset turnover ratios vary across different industries, so only ratios of companies belonging to the same industry should be compared. The ratio is usually calculated on an annual basis, although any period can be selected.
Key points to remember
- The asset turnover ratio analyzes how a company uses its assets to generate sales.
- The ratio is calculated by dividing a company’s net sales for a given period by the average total assets owned by the company during the same period.
- The asset turnover rate can be modified to analyze only the fixed assets of a company.
- Companies with a higher asset turnover rate are more efficient at using company assets to generate revenue.
- Like other ratios, the asset turnover ratio is very industry specific. Sectors like retail and food and beverage have high ratios, while sectors like real estate have lower ratios.
Calculation of asset turnover rate
The asset turnover ratio compares the performance of the income statement with the financial health of the company on the balance sheet. The formula is:
Asset turnover ratio = net sales / average total assets
Net sales are the total amount of revenue retained by a business. This is gross sales for a specific period less any returns, discounts, or discounts taken by customers. When comparing the asset turnover rate between companies, make sure the net sales calculations are taken from the same time period.
Average total assets are found by taking the average of the beginning and ending assets of the analyzed period. The standard asset turnover ratio takes into account all asset classes, including current assets, long-term assets and other assets.
Fixed Assets to Total Assets
A common variation of the asset turnover rate is the fixed asset turnover rate. Instead of dividing net sales by total assets, fixed asset sales divides net sales only by fixed assets. This variation isolates how efficiently a business uses its capital expenditures, machinery, and heavy equipment to generate revenue. The fixed asset turnover ratio focuses on the long-term prospects of a business, as it focuses on the performance of long-term investments in operations.
The asset turnover ratio is expressed as a rational number which may be a whole number or may include a decimal. By dividing the number of days in the year by the asset turnover rate, an investor can determine how many days it takes for the company to convert all of its assets into revenue.
Example of Asset Turnover Ratio
Suppose Company ABC had total revenue of $10 billion at the end of its fiscal year. Its total assets were $3 billion at the start of the fiscal year and $5 billion at the end. Assuming the company had no returns for the year, its net revenue for the year was $10 billion. The company’s average total assets for the year were $4 billion (($3 billion + $5 billion) / 2).
ABC Company Asset Turnover = $10 billion / $4 billion = 2.5
On the other hand, XYZ Company – a competitor of ABC in the same industry – had total revenue of $8 billion at the end of the same fiscal year. Its total assets were $1 billion at the start of the year and $2 billion at the end.
XYZ Company Asset Turnover = $8 billion / $1.5 billion = 5.33
Although ABC generated more revenue for the year, XYZ is more efficient in using its assets to generate revenue because it has a higher asset turnover rate. XYZ generated almost the same amount of revenue with more than half the resources as ABC.
Interpretation of the asset turnover ratio
Asset turnover rate is most useful when compared between similar companies. Due to the variable nature of different industries, it is more valuable when compared between companies in the same industry.
Asset turnover ratio can also be analyzed by following the ratio of a single company over time. As the business grows, the asset turnover rate measures how effectively the business expands over time, especially relative to the rest of the market. Although a company’s total revenue may increase, the rate of asset turnover can determine whether that company becomes more or less efficient in effectively using its assets to generate profits.
Companies can artificially inflate their asset turnover rate by selling assets. This improves the company’s asset turnover rate in the short term because 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 calculation of the asset turnover ratio can be modified to omit these uncommon income occurrences.
Low or high asset turnover ratios
The rate of asset turnover will vary from sector to sector. Industries open to the public, including retail and restaurants, rely heavily on converting assets into inventory and then converting inventory into sales. Other sectors like real estate often take long periods to convert inventory into income. Although real estate transactions can result in high profit margins, the industry-wide asset turnover rate is low.
A key component of DuPont’s analysis is asset turnover. A system that began being used in the 1920s to assess the performance of a company’s divisions, 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 rate?
Higher asset turnover ratio results indicate that a company is better able to move products to generate revenue. As each industry has its own characteristics, favorable asset turnover ratio calculations will vary from industry to industry.
What does an asset rotation of one mean?
An asset turnover ratio of one means that a company’s net sales for a specific period are equal to the average assets for that period. The business generates $1 in sales for every dollar the business has in assets.
How is the asset turnover ratio used?
The asset turnover ratio is used to gauge how effectively a company uses its assets to generate sales. It can be used to compare a company’s performance against its competitors, the rest of the industry, or its past performance.
The asset turnover ratio helps investors understand how effectively companies are using their assets to generate sales. Investors use this ratio to compare similar companies in the same industry or group to determine who is making the most of their assets. Asset turnover ratio is calculated by dividing net sales or income by average total assets.