Asset Turnover Ratio
What Is the Asset Turnover Ratio?
The asset turnover ratio is a financial metric that measures the efficiency of a company’s use of its assets. The asset turnover ratio can be used to evaluate how well a company is using its assets to generate revenue.
The asset turnover ratio is calculated by dividing a company’s total sales by its total assets.
A high asset turnover ratio indicates that a company is generating a lot of sales with relatively few assets.
A low asset turnover ratio indicates that a company is not using its assets efficiently to generate sales.
The asset turnover ratio is a helpful metric for investors to use when evaluating companies.
However, it is important to keep in mind that the asset turnover ratio should be considered along with other financial metrics, such as the return on asset (ROA) and return on equity (ROE) ratio, to get a complete picture of a company’s financial health.
Formula and Calculation of the Asset Turnover Ratio
The asset turnover ratio is calculated by dividing a company’s total sales by its total assets.
For example, if a company has total sales of $100 million and total assets of $50 million, the asset turnover ratio would be 2 ($100 million/$50 million).
This means that for every $1 of assets, the company generates $2 in sales.
Many will also calculate it as total sales divided by average assets over the course of the year or time period.
For example, if a company had $100 million in total sales and total assets of $40 million at the beginning of the year and $60 million at the end of the year, they would average the two asset amounts ($50 million) and then divide the two numbers.
Likewise, the asset turnover ratio would be 2 ($100 million/$50 million).
Importance of the Asset Turnover Ratio
The asset turnover ratio is a helpful metric for investors to use when evaluating companies.
A high asset turnover ratio indicates that a company is using its assets efficiently to generate sales.
A low asset turnover ratio indicates that a company is not using its assets efficiently.
Asset Turnover Ratio and DuPont Analysis
The asset turnover ratio is often used in conjunction with the return on asset ratio to get a more complete picture of a company’s financial health. This analysis is known as the DuPont analysis.
The DuPont analysis is a framework that decomposes the return on asset ratio into three component ratios:
- The asset turnover ratio
- The financial leverage ratio
- The profit margin ratio
The asset turnover ratio measures the efficiency of a company’s use of its assets.
The financial leverage ratio measures the amount of debt a company is using to finance its assets. The profit margin ratio measures the profitability of a company’s sales.
The DuPont analysis is a helpful tool for investors because it provides insight into the factors that are driving a company’s return on asset ratio.
For example, if a company has a high asset turnover ratio but a low profit margin ratio, this could indicate that the company is good at generating sales but not doing so with optimal efficiency.
On the other hand, if a company has a low asset turnover ratio but a high financial leverage ratio, this could indicate that it sells efficiently but may have trouble selling the inventory it does sell.
Difference Between Asset Turnover and Fixed Asset Turnover Ratios
There are differences between the two different asset turnover ratios:
- the asset turnover ratio and
- the fixed asset turnover ratio
The asset turnover ratio measures a company’s total sales divided by its total assets.
The fixed asset turnover ratio measures a company’s total sales divided by its fixed assets.
Fixed assets are a company’s long-term assets, such as buildings, land, and machinery (sometimes called plant, property, and equipment (PP&E)).
The asset turnover ratio is a more comprehensive measure of a company’s asset efficiency because it includes all types of assets, not just fixed assets.
However, the fixed asset turnover ratio can still be helpful in certain situations.
For example, if a company is considering expanding its operations, the fixed asset turnover ratio can be a helpful metric to use in order to evaluate whether the company has the capacity to generate sales with its existing fixed assets.
Limitations of Using the Asset Turnover Ratio
There are some limitations to using this ratio:
Quality of assets
The asset turnover ratio does not take into account the quality of assets.
For example, a company could have high-quality assets that generate a lot of sales or low-quality assets that generate few sales.
Financial leverage ratio
The asset turnover ratio also does not take into account the financial leverage ratio.
The financial leverage ratio is important because it measures the amount of debt a company is using to finance its assets.
A company with a lot of debt may have a high asset turnover ratio but be at risk of defaulting on its loans.
Does not measure profitability
The asset turnover ratio only measures asset efficiency and does not measure profitability. The profit margin ratio is a better metric to use if you are interested in evaluating a company’s earnings.
May be gamed
The asset turnover ratio may be artificially high if a company is selling off its assets.
For example, if a company sells its inventory at a discount in order to generate sales, this will increase the asset turnover ratio but may not be indicative of the company’s underlying asset efficiency.
The asset turnover ratio may be artificially low if a company is holding on to its assets for a long time.
For example, if a company is waiting for the perfect time to sell its assets, this will decrease the asset turnover ratio but may not be indicative of the company’s underlying asset efficiency.
A company can also change how it accounts for depreciation to alter the accounting value of its fixed assets.
Asset Turnover Ratio – FAQs
What Does Asset Turnover Measure?
The asset turnover ratio measures the efficiency of a company’s use of its assets.
The asset turnover ratio is calculated by dividing a company’s total sales by its total assets.
What Is the Difference Between Asset Turnover and Fixed Asset Turnover?
The asset turnover ratio is a more comprehensive measure of a company’s asset efficiency because it includes all types of assets, not just fixed assets.
The fixed asset turnover ratio only measures the efficiency of a company’s use of its fixed assets.
What Are the Limitations of Using Asset Turnover Ratio?
There are some limitations to using asset turnover ratio:
– The asset turnover ratio does not take into account the quality of assets.
– The asset turnover ratio also does not take into account the financial leverage ratio.
– The asset turnover ratio only measures asset efficiency and does not measure profitability.
– The asset turnover ratio may be artificially high if a company is selling off its assets.
– The asset turnover ratio may be artificially low if a company is holding on to its assets for a long time.
Is a High or Low Asset Turnover Better?
When it comes to asset turnover, it ultimately depends, though a high asset turnover ratio is generally better than a low asset turnover ratio.
A high asset turnover ratio may be indicative of a company that is efficiently using its assets to generate sales.
A low asset turnover ratio may be indicative of a company that is not efficiently using its assets to generate sales.
It all depends on the context in which you are evaluating the asset turnover ratio.
What Is a Good Asset Turnover Value?
A good asset turnover ratio will depend on the industry in which the company operates.
Some industries have higher asset turnover ratios than others.
For example, the asset turnover ratio for retail companies is typically higher than the asset turnover ratio for manufacturing companies.
This has to do with the higher capital intensity of the latter, which generally gives it less efficiency.
How Can a Company or Business Entity Improve its Asset Turnover Ratio?
There are a few ways a company can improve its asset turnover ratio:
– Increase sales: One way to increase the asset turnover ratio is to increase sales.
– Decrease asset holding: Another way to increase the asset turnover ratio is to decrease asset holdings.
– Increase asset utilization: A third way to increase the asset turnover ratio is to increase asset utilization.
How Can the Asset Turnover Ratio Be Misleading?
A company can change its depreciation schedule for its fixed assets in order to change their accounting value.
A firm can also sell off assets as a way to earn money while its growth declines. This, in turn, has the effect of inflating the ratio.
Lastly, a company can hold on to its assets for a longer period of time as a way to reduce the asset turnover ratio.
This practice is usually done when the company expects the prices of its assets to increase in the future.
What Is an Example of Asset Turnover Ratio Analysis?
Let’s say Company A has total assets of $100,000 and total sales of $200,000.
This means that Company A has an asset turnover ratio of 2.0.
Now let’s say Company B also has total assets of $100,000 but its total sales are $150,000.
Company B has an asset turnover ratio of 1.5.
In this example, Company A is more efficient in its use of assets because it has a higher asset turnover ratio.
Summary – Asset Turnover Ratio
The asset turnover ratio is a financial metric that measures the efficiency of a company’s use of its assets in generating sales revenue.
The ratio is calculated by dividing a company’s total sales by its total assets.
A high asset turnover ratio indicates that a company is using its assets efficiently to generate sales.
A low asset turnover ratio indicates that a company is not using its assets efficiently to generate sales.
It is an important financial metric because it measures a company’s ability to generate sales revenue from its assets.
Investors use the asset turnover ratio to compare different companies and to assess a company’s financial health.
The asset turnover ratio is just one of many financial metrics that investors may use to assess a company.