Asset Turnover Ratio: Definition

The asset turnover ratio reflects the relationship between the value of the total assets held by a company and the value of its annual sales (i.e., turnover).

This ratio may seem unnatural, but it is helpful when assessing how efficiently the assets of a business are being used. After all, the main reason for holding an asset is to help the company achieve a certain level of sales.

An efficient company can deliver on its desired level of sales with a reasonable investment in assets.

By contrast, to achieve the same volume of business, a less efficient company will make a greater investment in assets (thereby incurring larger financial costs and, hence, recording a lower return on investment).

Industry averages provide a good indication of a reasonable total asset turnover ratio.

Formula For Asset Turnover Ratio

To calculate the asset turnover ratio, use the following formula:

Asset Turnover Ratio Formula

Example

Consider the following data taken from John Trading Concern:

  • Total assets at the beginning of the year 2019: $2,450,000
  • Total assets at the end of the year 2019: $2,350,000
  • Net sales made during the year 2019: $4,800,000

Required: Calculate and interpret the total asset turnover ratio of John Trading Concern for the year 2019.

Solution

Total asset turnover ratio = Sales/Average total assets

= $4,800,000/$2,400,000* = 2

* ($2,450,000 + $2,350,000)/2

The asset turnover ratio is 2. This means that every dollar invested in assets generates $2 in sales. Remember to compare this figure with the industry average to see how efficient the organization really is in using its total assets.

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Frequently Asked Questions

What does the asset turnover ratio tell us?

The asset turnover ratio tells us how efficiently a business is using its assets to generate sales. This is a good measure for comparing companies in similar industries, and can even provide a snapshot of a company's management practices. A lower ratio indicates that the company may be running inefficiently, with an upcoming need for additional assets or more space, which could lead to higher costs.

How is the asset turnover ratio calculated?

The formula for this metric is sales divided by average total assets. To calculate average total assets, add up the beginning and ending balances of all assets on your balance sheet. Then divide by 2, because you are taking an average of 2 periods. Be sure not to count anything twice in this calculation, like cash in the bank accounts, which would be included in both beginning and ending balances.

What's an advantage of measuring asset turnover?

This ratio is useful because it allows you to compare companies in similar industries when they are using different accounting methods (e.g., the LIFO method for determining inventory value, or Depreciation). In other words, companies may differ in their accounting treatment. But they will use assets similarly to make sales.

When is this ratio considered high?

High turnover means that the company uses a small percentage of its assets each year to generate huge amounts of sales. This is an indication of efficient management practices. However, it could be difficult to achieve high asset turnover if there are few assets to work with (for example, a company that manufactures custom clothes for each customer).

What's the difference between total assets and average total assets?

Total assets is the cumulative amount of everything your business owns. It's usually listed at the bottom of the balance sheet. Average total assets is calculated by adding up all your assets and dividing by 2, since you are calculating an average for 2 periods (beginning of year plus ending of year).

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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