The asset turnover ratio compares a company's total average assets to its total sales. The ratio helps investors determine how efficiently a company is using its assets to generate sales.
What Is the Asset Turnover Ratio?
The success of any company is largely based on its ability to effectively use its assets to generate sales. The asset turnover ratio measures the efficiency with which a company uses its assets to generate sales by comparing the value of its sales revenue relative to the average value of its assets.
Companies rely on their working capital to generate sales revenue. Working capital consists of a company's cash flow as well as its assets. The asset turnover ratio is a financial measure of how efficiently a company utilizes its assets to produce sales revenues.
High vs. Low Asset Turnover Ratio
Generally, companies with a high asset turnover ratio are more efficient at generating revenue through their assets, while those with a low ratio are not. This ratio can be a useful point of comparison for investors to evaluate the operations of different companies and their potential as an investment.
Companies that don't rely heavily on their assets to generate revenue have a higher asset turnover ratio than companies that do. They tend to perform better because they use less equity and debt to produce revenue, resulting in more revenue generated per dollar of assets. For investors, that can translate into a greater return on shareholder equity. Companies with a lower asset turnover ratio may be relying too heavily on equity and debt to generate revenue, which can hurt their performance and long-term growth potential.
Key Takeaway: Companies with higher asset turnover ratios tend to perform better because they use less equity and debt to produce revenue.
Asset Turnover Ratio Formula & Calculation
The formula for calculating asset turnover ratio consists of two factors:
- A company's net sales: its gross sales after accounting for returns, discounts, and allowances
- Its total assets: the total of its equity and liabilities at the beginning of the year plus the total at the end of the year divided by two.
The formula is expressed as:
Asset Turnover Ratio = Net Sales / Total Assets
How To Calculate Asset Turnover Ratio
The formula's components (net sales and total assets) can be found in a company's financial statements. To determine the value of net sales for the year, look to the company's income statement for total sales. It could also be recorded as revenue. The figure should be net of discounts, allowances, and returns.
To determine the average value of the company's assets for the year:
- Look to its balance sheet for the value of its assets at the beginning of the year.
- Look for the value of the company's assets at the end of the year.
- After adding the beginning value to the ending value, divide the sum by two to reveal the average asset value, or total assets, for the year.
The total assets figure becomes the denominator for the asset turnover ratio.
Understanding Asset Turnover Ratio
Among the more important considerations for investors when evaluating a company is how efficiently it utilizes its assets to produce revenue. Generally, capital-intensive companies with a high asset turnover ratio have the capacity to operate with fewer assets than their less efficient competitors that might rely heavily on their equity and debt to operate. These companies have greater potential to grow and compound their earnings over time.
However, experienced investors avoid relying on a single, one-year reading of the ratio as it can fluctuate. Or it can be impacted by one-time events, such as when a company deliberately increases its inventory to fulfill a large, one-off customer order or sells off a significant portion of its inventory in a short period of time. For that reason, investors should look at the ratio's trend over time.
Also, a high turnover ratio does not necessarily translate to profits, which is a more accurate way to measure a company's performance. For example, companies that outsource a large portion of their production can have a much higher turnover but fewer profits than their competitors.
A thorough analysis considers the asset turnover ratio in conjunction with other measures, such as return on assets, for a clearer picture of a company's performance.
What's a Good Asset Turnover Ratio?
It's important to note that comparisons of asset turnover ratios are only meaningful for evaluating companies in the same sector or industry. There is no particular figure that constitutes a good or bad ratio. Ratios can vary widely from sector to sector. Some sectors, such as retail and consumer staples, tend to have smaller asset bases with high sales volume, resulting in higher ratios because they need to replace their inventories at a high rate each year.
Conversely, telecommunications and utility companies have large asset bases that turn over more slowly compared to their sales volume. So, comparing the asset turnover ratio between a retail company and a telecommunication company would not be meaningful. However, looking at the ratios of two telecommunication companies would be a productive comparison.
Service industry companies, such as financial services companies, typically have smaller asset bases or a heavier reliance on intangible assets, making the ratio less meaningful as a comparison tool.
Important: The asset turnover ratio should only be used to compare similar companies within the same industry or sector.
Asset Turnover Ratio Example
As an example of how the asset turnover ratio is applied, consider the net sales and total assets of two fictional retail companies.
Net Sales (Revenue)
Average Total Assets
Asset Turnover Ratio
The asset turnover ratios for these two retail companies provide for a straight-across comparison of their performance.
- Company X generated $2.33 in sales per dollar of asset.
- Company Y generated $1.77
This shows that company X is more efficient in its use of assets to produce revenue. The lower ratio for Company Y may indicate sluggish sales or carrying too much obsolete inventory. It could also be the result of assets, such as property or equipment, not being utilized to their optimum capacity.
Asset Turnover Ratio vs. Fixed Asset Turnover
Asset management ratios such as the asset turnover ratio are critical to analyzing how a company manages its assets to generate revenue. Some investors or analysts are more concerned with how a company manages its fixed assets and the efficiency with which they are used to generate sales revenue. Whereas the asset turnover ratio looks at a company's total assets, the fixed asset ratio only considers its fixed assets. Fixed assets are reported on the balance sheet net of accumulated depreciation, and can include:
While the fixed asset ratio is also an efficiency measure of a company's operating performance, it is more widely used in manufacturing companies that rely heavily on plants and equipment. As with the asset turnover ratio, the fixed asset turnover ratio measures operational efficiency, but it is less likely to fluctuate because the value of fixed assets tends to be more static. Companies with a high fixed asset ratio tend to be well-managed companies that are more effective at utilizing their investments in fixed assets to produce sales.
Key Takeaway: While the asset turnover and fixed asset turnover ratios are similar, the fixed asset ratio is more meaningful for companies with significant investments in property, plants, and equipment.
Where To Find & Compare Asset Turnover Ratios
The asset turnover ratio can be used to compare the performance of competing companies within the same industry to determine which ones are better at generating more revenue buck for their asset dollar. Seeking Alpha's Peer Comparison tool (below) helps compare asset turnover ratios of competing companies (under the Peers > Profitability subset for each company):
Premium subscribers also get access to the Profitability Grades feature under Seeking Alpha's Quant Ratings tool, where they can see how a company grades in terms of its asset turnover ratio relative to its sector and how different the asset turnover ratio is from the sector median and from its own 5-year average.
This could be particularly useful for analyzing companies within sectors which usually have large asset bases.
Investors can use the asset turnover ratio to measure how efficiently a company uses its assets to generate sales revenue. A higher asset turnover ratio implies a company is generating a higher level of revenue per dollar invested in its assets. The ratio can then be used to compare a company with its competitors within the same industry.
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