Asset turnover is a key measure of how effectively a business uses its resources to generate sales. It helps determine a company's financial performance by showing how much revenue is produced for every dollar invested in its assets. A higher asset turnover generally indicates that a company is using its assets more efficiently.
To calculate asset turnover, you divide the net sales (or gross revenue) by the average total assets. This calculation is often done annually. The formula looks like this:
Asset Turnover = Net Sales ÷ Average Total Assets
Or, from another source:
Asset Turnover Ratio = Gross Revenue ÷ Average Total Assets
To find the average total assets, you add the total assets at the beginning of the fiscal year to the total assets at the end of the fiscal year, then divide that sum by two:
Average Total Assets = (Beginning Assets + Ending Assets) ÷ 2
Consider a company with $10 million in annual sales and $10 million worth of assets; its asset turnover is 1.0 ($10M/$10M). Another company, with $100 million in annual sales and $20 million worth of assets, has an asset turnover of 5 ($100M/$20M). These numbers are often called asset turnover ratios or asset turns.
In another scenario, Company A has a gross revenue of $20 billion. Its beginning assets were $5 billion, and ending assets were $7 billion. The average total assets are $6 billion (($5B + $7B) ÷ 2), making its asset turnover ratio 3.33 ($20B ÷ $6B). Company B has $15 billion in gross revenue, with beginning assets of $4 billion and ending assets of $2 billion. Its average total assets are $3 billion (($4B + $2B) ÷ 2), resulting in an asset turnover ratio of 5 ($15B ÷ $3B). In this case, Company B utilizes its assets more effectively to generate revenue than Company A
A higher asset turnover ratio is better. It means the business is generating more sales revenue from each dollar invested in its assets. For instance, an asset turnover ratio of 2x indicates that for every $1 spent on assets like machinery and equipment, the company generates $2 in sales revenue. This is positive news for investors, showing that the company is effectively utilizing its capital.
A high ratio also suggests that a business can operate efficiently with fewer assets compared to its less efficient competitors. This can lead to less need for debt and equity, reducing risk and potentially increasing the return on investment (ROI) for all stakeholders.
A low asset turnover ratio signals that a company is not using its resources productively and might be facing internal challenges. For a manufacturing facility, a low ratio could indicate that assets (like equipment) and liabilities (like loans) are not aligned to achieve break-even or profit targets from sales. This information can prompt teams to make necessary adjustments, such as increasing production volume to meet financial goals.
It is important to look at trends in a company's asset turnover ratio over time to observe any patterns or gradual changes. Comparing a company's asset turnover ratio to other similar companies within its industry is also crucial for gaining the best understanding of how efficiently it uses its resources. Note that asset turnover ratios can vary significantly across different industries. For example, retail businesses often have smaller asset bases but high sales volumes, leading to higher asset turnover ratios. In contrast, sectors like utilities and real estate typically have large asset bases and lower sales volumes, resulting in much lower asset turnover ratios.
Tracking asset turnover provides valuable insights into a business's performance:
Companies can implement several strategies to enhance their asset turnover:
The concept of asset turnover is particularly relevant in maintenance management and industrial applications. Efficient maintenance practices directly contribute to higher asset turnover.
While a valuable tool, the asset turnover ratio does have some limitations and should be considered alongside other financial metrics for a complete analysis:
It is important to distinguish the asset turnover ratio from the fixed asset ratio. Both measure how efficiently a company uses assets to generate revenue, but they focus on different types of assets:
Fixed assets are long-term resources purchased by the company with the intent of long-term use, such as land, buildings, and equipment.
