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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