Ever thought about how to get the most out of your business assets? Or is your turnover increasing against the investment in your business asset? This is where asset turnover ratio steps in!
This metric shows how well a company is converting its investments into assets, like, equipment, property, or inventory, into revenue. A higher ratio indicates how efficiently a company is using its resources, while a lower ratio indicates the underutilisation of assets.
This article will provide a detailed understanding of what is asset turnover ratio, why it matters, and how to calculate it.
So, let’s get into it!
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What is Asset Turnover Ratio?
An asset turnover ratio is a financial metric that helps measure how effectively a company uses its assets to create sales.
A higher ratio suggests that a company is efficiently managing its assets to generate revenue, while a low ratio may indicate inefficiencies or underutilisation of assets.
Asset Turnover Ratio – Formula and Calculation with Example
The asset turnover ratio can be calculated by dividing the net sales of a company by the average of the total assets owned by the company.
Formula
Asset Turnover Ratio = Net Sales / Average Total Assets
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- Net Sales are the total revenue of a company after accounting for returns, discounts, and allowances.
- The average total assets are calculated by dividing the total assets at the beginning of the period and the total assets at the end of the period, adding them together, and dividing by two.
- Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
Example
Net Sales = £600,000
Total Assets at Beginning of Year = £900,000
Total Assets at End of Year = £1400,000
Average Total Assets = (£900,000 + £1400,000) / 2 = £1150,000
Asset Turnover Ratio = £600,000 / £1150,000 = 0.52
This means the company is generating £0.52 in net sales for every £1 of assets.
Importance Of Asset Turnover Ratio
After learning what is Asset Turnover Ratio, it is also important to know why it is crucial. The following are the reasons why Asset Turnover ratio is vital:
- It measures the efficiency of a company to show how effectively it is converting assets into revenue.
- It allows investors and analysts to compare a company’s performance against other companies within the same industry.
- A lower ratio can indicate that a company has too many underused assets or poor inventory management, suggesting a need for strategic changes.
- While a higher ratio suggests that a company is productive and can generate more sales from its existing asset base.
What Is a “Good” Asset Turnover Ratio?
A “good” asset turnover ratio is not a single number but varies according to the industry, so it is better to compare it with the companies of the same sector. A higher ratio indicates better efficiency, meaning a company generates more revenue per pound of assets.
For example, a ratio of 2.5 or higher might be considered good for a retail company, while a utility company might aim for a ratio between 0.25 and 0.5.
How To Improve Your Asset Turnover Ratio?
To improve your Asset Turnover Ratio, you need to generate either more sales with your existing assets or use fewer assets to generate the same amount of sales.
Increasing Net Sales
- Introducing new products or service lines which do not require significant new asset investments.
- Implementing marketing campaigns or offering incentives to boost sales.
- Focusing on selling higher-margin products or services.
Reducing Total Assets
- Implementing better systems to reduce excess inventory and associated holding costs.
- Speeding up the collection of accounts receivable.
- Consider leasing some assets instead of purchasing them to keep them off the balance sheet and lower total assets.
Asset Turnover vs. Fixed Asset Turnover – Key Differences
Asset Turnover Ratio focuses on measuring a company’s ability to generate more sales from its total assets, while the Fixed Asset Turnover Ratio measures efficiency using only fixed assets.
Both are calculated using the same formula. A higher ratio indicates greater efficiency in either fixed or total asset utilisation. The following are some key differences between the two:
| Aspects | Asset Turnover Ratio | Fixed Asset Turnover Ratio |
| Purpose | To assess how effectively a company uses all its assets (short-term and long-term) to generate revenue. | To assess how efficiently a company uses its fixed assets (like Property, Plant and Equipment) to generate sales. |
| Scope | Considers all assets, like current assets (inventory and cash) and fixed assets (PP&E). | Focuses only on Property, Plant, and Equipment (PP&E) |
| Industrial Context | Provides a general overview of asset utilisation for any type of business. | Relevant for sectors with larger investments in physical infrastructure, like manufacturing, real estate, and utilities. |
| Metrics Measured | Measures the overall efficiency of a company by using its assets to generate revenue. | Assesses how well a company uses its long-term, capital-intensive investment to generate sales. |
Factors To Consider While Calculating the Asset Turnover Ratio
Calculating the Asset Turnover Ratio is based on various factors, which are described below:
Industrial Comparisons
The asset turnover ratio is not an overall comparable metric. Only compare the ratios of companies within the same industry, as different industries use different asset intensities and operational models.
Time Period
This ratio is usually calculated on an annual basis, but can be applied to any period for which you have sales and asset data.
Outdated Assets
Unused or outdated inventory or other unproductive fixed assets can lower the ratio, indicating inefficient use of assets.
Sales Performance
Slow sales can result in a lower turnover ratio, even if the company’s assets are functioning efficiently.
Inventory And Receivables Management
Poor inventory management or collection methods for accounts receivable can negatively impact the ratio.
Limitations Of The Asset Turnover Ratio
While there are some positive points about what is Asset Turnover Ratio, there are also some drawbacks. The following are the limitations of the Asset Turnover Ratio:
Industry Variation
This ratio varies significantly across industries. The capital-intensive businesses, like manufacturing, will naturally have a lower ratio than retail businesses. This can make it difficult to compare across different industries.
Asset Quality
This ratio does not consider the age or quality of assets. A company with older, fully depreciated assets may show signs of a high turnover, but could be facing future investment needs.
External Factors
This ratio does not account for external economic factors, like a downturn in the economy, that can impact sales regardless of how efficiently assets are managed.
Intangible Assets
The basic asset turnover ratio includes all assets. Depending on the specific needs, a company might want to calculate a Fixed Asset Ratio (fixed assets) to get more specific insights.
Bottom Line
Now that you have understood what is asset turnover ratio, it is not just a financial formula; it is a clear picture of how well your business is putting its assets to work.
This ratio varies from industry to industry, like the industries having a below-average margin of profit need to generate a higher ratio, whereas the ones with higher financial demand need to have a lower asset turnover ratio.
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Disclaimer: All the information provided in this article on what is asset turnover?, including all the texts and graphics, is general. It does not intend to disregard any of the professional advice.\