Asset Turnover Ratio

Asset turnover ratio is the ratio of a company's sales to its assets. It is an efficiency ratio which tells how successfully the company is using its assets to generate revenue.

The most popular asset turnover ratio is the total assets turnover ratio which equals net sales divided by average total assets. Other asset turnover ratios include fixed assets turnover ratio and working capital turnover ratio. In all cases the numerator is the same i.e. net sales (both cash and credit) but denominator is average total assets, average fixed assets, and average working capital, respectively.

Formula

Total assets turnover ratio is calculated using the following formula:

Total Assets Turnover Ratio =Net Sales
Average Total Assets

Net sales equals gross sales minus any sales tax or VAT, sales returns and trade discounts.

Average total assets value is calculated by adding the beginning and ending balance of total assets and dividing the sum by 2.

Analysis

If a company can generate more sales with fewer assets it has a higher turnover ratio which tells us that it is using its assets more efficiently. On the other hand, a lower turnover ratio shows that the company is not using its assets optimally.

Total asset turnover ratio is a key driver of return on equity as discussed in the DuPont analysis.

Example

As at 1 January 20X1, Gamma had total assets of $100, total fixed assets of $60 and net working capital of $20. During FY 20X1 it generated sales of $200 with COGS of $160 and its total assets as at 30 December 20X1 were $120. During the year it charged depreciation of $10 and there were no fixed asset additions during the year. Current assets and current liabilities were $50 and $30 as at the year end. Calculate total asset turnover, fixed asset turnover and working capital turnover ratios.

Solution

Average total assets = (100+120)/2 = $110, sales are $200 so total asset turnover is $200/$110 = 1.82. If the industry average total asset turnover ratio is 1.2, we can conclude that the company has used its asset more effectively in generating revenue.

Opening fixed assets were $60, closing fixed assets are $60-$10=$50. Average fixed assets are hence ($60+$50)/2=$55. This gives us fixed asset turnover of $200/$55 = 3.63

Opening working capital is $20, closing working capital is $20 ($50-$30); this gives us average working capital of $20 and resulting working capital turnover ratio of $200/$20=10.

Asset turnover ratio should be looked at together with the company's financing mix and its net profit margin for a better analysis as discussed in DuPont analysis.

by Obaidullah Jan, ACA, CFA and last modified on

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