Asset Turnover Ratio Analysis Formula Example

what is a good asset turnover ratio

The current assets turnover ratio is a signal for the future of the company that is measured in present terms. It provides a view into the sales figures that, in turn, can show the profitability or performance of the company in the market.

This can be done by plotting the data points on a trend line, allowing any patterns or gradual increases and decreases to be observed. However, in order to gain the best understanding of how a company is using its resources, its asset turnover ratio must be compared to other similar companies in its industry. One way businesses manipulate the asset turnover ratio is to sell off part of their assets in preparation for a period of declining growth, which will then artificially inflate this ratio. For example, retail companies tend to have a high volume of sales and a reasonably small asset base, which gives them a high asset turnover ratio. If a business has a higher asset turnover ratio, it shows that the business is efficient at using its assets to generate revenue. In order to measure the return on sales, the sales return should be subtracted from net sales. This gives a true value of current sales that is applicable to the measurement of the current assets turnover ratio.

Asset Turnover Ratio Defined

Thus, to calculate the asset turnover ratio, divide net sales or revenue by the average total assets. One variation on this metric considers only a company’s fixed assets instead of total assets. Total Sales are the total sales made that year, also called total annual revenue, and are found on a company’s income statement. Beginning and Ending Assets are listed as Total Assets on a balance sheet and are the total assets a company has at the end of that year. Asset turnover ratios are asset turnover ratio compared against those of other companies in order to determine how well a company is performing in its industry. In order to determine the asset turnover ratios of their competitors, a company uses the financial statements to gather the values needed for the ratio formula and then calculate. This efficiency ratio compares net sales to fixed assets and measures a company’s ability to generate net sales from its fixed-asset investments, namelyproperty, plant, and equipment(PP&E).

  • Third, a company may have chosen to outsource its production facilities, in which case it has a much lower asset base than its competitors.
  • As expected, their competitor has a better ratio because they are selling more products.
  • For instance, a ratio of 1 means that the net sales of a company equals the average total assets for the year.
  • The asset turnover ratio is a measurement that shows howefficientlya company is using its owned resources to generate revenue or sales.

For example, telecommunications companies typically have large asset bases, so it takes more time to turn over these assets into revenue, and as such, their ratios are often less than 1. This is where the comparison to other companies within the same industry becomes helpful.

What is the asset turnover ratio?

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. Since this ratio can vary widely from one industry to the next, comparing the asset turnover ratios of a retail company and a telecommunications company would not be very productive. Comparisons are only meaningful when they are made for different companies within the same sector. There are several reasons why the asset turnover ratio may increase.

what is a good asset turnover ratio

The company is then not investing a larger amount of money in a stock that will likely sit on shelves and instead only orders it when it is needed. Another option to improve the Asset Turnover Ratio is to decrease the company’s total assets in the balance sheet. Clearing old slow-moving inventory and selling off unused production capacities will improve the ratio and cash inflow. As an example of how the asset turnover ratio is applied, consider the net sales and total assets of two fictional retail companies.

Asset Turnover Ratio Video

Therefore, the current assets turnover ratio, when expressed in percentage terms, indicates the net sales that have occurred due to the investment of each Rs. 100 in the process. You can compare your company’s current asset turnover ratio with others in the same industry to see how you stack up.

How is asset turnover calculated?

  1. Asset Turnover Ratio = Net Sales / Average Total Assets.
  2. ABC Company's Asset Turnover Ratio = $10 billion / $4 billion = 2.5.
  3. XYZ Company's Asset Turnover Ratio = $8 billion / $1.5 billion = 5.33.

This shows that company X is more efficient in its use of assets to produce revenue. The lower ratio for Company Y may indicate sluggish sales or carrying too much obsolete inventory. It could also be the result of assets, such as property or equipment, not being utilized to their optimum capacity. When calculating and analyzing asset turnover ratio for your company, be sure you only compare results to those in similar industries. That means that for every dollar of assets Don’s business has, it’s only earning $0.68 in sales. This result indicates that Don’s business is not using its assets efficiently. In either case, calculating the asset turnover ratio will let you know how efficiently you’re using the assets you have.

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In other words, every $1 in assets generates 25 cents in net sales revenue. Using this ratio to compare companies in the same industry will be preferable to compare companies across industries. On the other side, selling assets to prepare for declining growth will result in an artificial inflation of the ratio.

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If a company’s ratio is lower than most other companies within that industry, it needs to improve. So, if a company has a ratio of, say, 3.4, but their competitors have a ratio of 3.9. They are not doing as well as other companies, even though they make $3.40 for every dollar in assets. First, it assumes that additional sales are good, when in reality the true measure of performance is the ability to generate a profit from sales. Thus, a high turnover ratio does not necessarily result in more profits. Second, the ratio is only useful in the more capital-intensive industries, usually involving the production of goods.