Asset Turnover Ratio Explained

asset turnover ratio meaning

Changing depreciation methods for fixed assets can have a similar effect as it will change the accounting value of the firm’s assets. Generally, a higher ratio is favored because it implies that the company is efficient in generating sales or revenues from its asset base. A lower ratio indicates that a company is not using its assets efficiently and may have internal problems.

What Do Efficiency Ratios Measure? – Investopedia

What Do Efficiency Ratios Measure?.

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This gives a true value of current sales that is applicable to the measurement of the current assets turnover ratio. There are a host of turnover ratios that are to be measured along with the current asset turnover ratio. Since this is a measure of efficient asset turnover ratio utilization of assets by a company to generate sales the higher the ratio the more favorable it is. We have discussed how you would be able to calculate the asset turnover ratio and would also be able to compare among multiple ratios in the same industry.

Asset Turnover in Relation to Profit

The higher the number the better would be the asset efficiency of the organization. It’s being seen that in the retail industry, this ratio is usually higher, i.e., more than 2. Like with most ratios, the asset turnover ratio is based on industry standards.

Suppose company ABC had total revenue 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 was $10 billion. The company’s average total assets for the year was $4 billion (($3 billion + $5 billion) / 2 ). Sectors like retail and food & beverage have high ratios, while sectors like real estate have lower ratios.

Step 3. Perform the calculation

A company’s asset turnover ratio can be impacted by large asset sales as well as significant asset purchases in a given year. After adding the beginning value to the ending value, divide the sum by two to reveal the average asset value, or total assets, for the year.

The returns and refunds should be withdrawn out of the total sales, in order to accurately measure a firm’s asset capability of generating sales. The higher the current asset turnover ratio, obviously the better it is because a higher score in asset turnover means more sales obtained for an investment of a fixed amount (usually Rs. 100). That is why the creditors look for higher current asset turnover ratios to offer loans to eligible companies. While both the asset turnover ratio and the fixed asset ratio reveal how efficiently and effectively a company is using their assets to generate revenue, they go about it in different ways. Consider a company, Company A, with a gross revenue of $20 billion at the end of its fiscal year.

How to calculate the asset turnover ratio

By contrast, a low ratio could be a sign of inefficiency, although the ratios are most effective when compared with companies in similar industries. While the fixed asset ratio is also an efficiency measure of a company’s operating performance, it is more widely used in manufacturing companies that rely heavily on plants and equipment. As with the asset turnover ratio, the fixed asset turnover ratio measures operational efficiency, but it is less likely to fluctuate because the value of fixed assets tends to be more static. Companies with a high fixed asset ratio tend to be well-managed companies that are more effective at utilizing their investments in fixed assets to produce sales. It measures a company’s ability to generate sales from its assets by comparing net sales with total assets. This tells us about how efficiently a company is utilizing its assets to generate sales.

The assets documented at the start of the year totaled $5 billion and the total assets at the end of the year were documented at $7 billion. Therefore, the average total assets for the fiscal year are $6 billion, thus making the asset turnover ratio for the fiscal year 3.33. By comparing companies in similar sectors or groups, investors and creditors can discover which companies are getting the most out of their assets and what weaknesses others might be experiencing. If you see your company’s asset turnover ratio declining over time but your revenue is consistent or even increasing, it could be a sign that you’ve “overinvested” in assets. It might mean you’ve added capacity in fixed assets – more equipment or vehicles – that isn’t being used. Or perhaps you have assets that are doing nothing, such as cash sitting in the bank or inventory that isn’t selling.