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:
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.
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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