Asset Turnover Ratio

Asset turnover ratio is the ratio of a company's net sales to its average total assets. It is an asset-utilization ratio which tells us how efficiently the company is using its assets to generate revenue.

Asset turnover ratio is also called total assets turnover ratio. There are other turnover ratios, such as the 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.

The asset turnover ratio is time-dependent in that a ratio for one month would be 1/12th of the ratio for a whole year.

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. However, in DuPont analysis, it is based on closing total assets instead of average total assets.

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

First, we need to find average total assets by adding opening and closing total assets and dividing by 2. In this case, average assets are $110 (=(100+120)/2). Since sales are $200, total asset turnover ratio is 1.82 (=$200/$110). If the industry average total asset turnover ratio is 1.2, we can conclude that the company has used its assets more effectively in generating revenue.

As opening fixed assets were $60, closing fixed assets are $60-$10=$50. Hence, average fixed assets are ($60+$50)/2=$55. This gives us a fixed asset turnover ratio of $200/$55 = 3.63

Since opening working capital is $20, and closing working capital is $20 ($50-$30), average working capital of $20 and the working capital turnover ratio would be 10 (=$200/$20).

Total 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
Studying for CFA® Program? Access notes and question bank for CFA® Level 1 authored by me at AlphaBetaPrep.com

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