Asset Turnover Ratio

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What is the asset turnover ratio?

The asset turnover ratio is a financial indicator that assesses how well a business makes use of its assets to produce income. The computation involves dividing the total assets averaged over a certain period by the net sales or revenue. 

The amount of money a business makes from its main operations after subtracting any allowances, returns, or discounts is known as net sales or revenue. The average total asset value is the sum of all the assets that a business has or is in control of, including cash, inventory, real estate, machinery, and intangible assets.

The asset turnover ratio can be used to assess changes in a company's efficiency over time or to compare the performance of various businesses operating in the same sector or industry. A lower ratio implies that a corporation is less efficient or has idle or underutilized assets, whereas a larger ratio shows that a company is more effective in employing its assets to generate sales.

Why is the asset turnover ratio important?

The asset turnover ratio is significant because it shows how well a business runs its operations and allocates its resources to generate value for its clients and investors. A high asset turnover ratio suggests that a business has a lower capital intensity and a higher potential for profitability since it can produce more sales with a smaller investment in assets.

In contrast, a low asset turnover ratio suggests that a business needs more assets to generate the same amount of sales, indicating a higher capital intensity and a lesser possibility for profitability.

The asset turnover ratio can also reveal information about a company's business strategy and competitive edge. For instance, businesses in high-volume, low-margin industries like retail or consumer staples typically have high asset turnover ratios since their revenue streams are based on selling huge quantities of goods at low prices.

Businesses in high-margin, low-volume industries like software and pharmaceuticals typically have low asset turnover ratios since their revenue is derived from selling a small number of products at high prices.

Formula for asset turnover ratio

The formula for the asset turnover ratio is:

Asset Turnover Ratio = Net Sales / Average Total Assets

Net sales and average total assets from a company's financial records are required in order to compute the asset turnover ratio. Net sales are reported on the income statement. The average total assets are computed by squaring the total assets from the balance sheet at the beginning and end levels.

For example, suppose that Company A has net sales of $10 million and average total assets of $5 million for the year 2020. The asset turnover ratio for Company A is:

Asset Turnover Ratio = $10 million / $5 million
Asset Turnover Ratio = 2

This means that Company A generated $2 of sales for every $1 of assets in 2020.

How to calculate the asset turnover ratio?

Division of net sales by average total assets is required to determine the asset turnover ratio. When a business subtracts client allowances, returns, and discounts, its net sales represent the total amount of money it keeps. The mean of the start and finish assets for the period under study is the average of the total assets.

The formula for the asset turnover ratio is:

Asset Turnover Ratio = Net Sales / Average Total Assets

For example, if a company has net sales of $10 million and average total assets of $5 million, its asset turnover ratio is:

Asset Turnover Ratio = $10 million / $5 million

Asset Turnover Ratio = 2

This means that the company generates $2 of sales for every $1 of assets.

Examples of asset turnover ratio

According to how asset-intensive they are, different industries have varying amounts of asset turnover ratios. Examples of industries with significant sales volumes but relatively modest asset bases include retail and consumer staples, which are known to have high asset turnover ratios. The real estate and utility sectors, on the other hand, often have low asset turnover ratios due to their low sales volumes and vast asset bases.

Here are some examples of asset turnover ratios for some companies in different sectors, based on their financial statements for the year 2022:

Walmart (retail)

Net sales = $559.2 billion

Average total assets = $252.5 billion

Asset turnover ratio = 2.21

Coca-Cola (consumer staples)

Net sales = $37.3 billion

Average total assets = $86.4 billion

Asset turnover ratio = 0.43

Apple (technology)

Net sales = $365.8 billion

Average total assets = $354.1 billion

Asset turnover ratio = 1.03

Exxon Mobil (energy)

Net sales = $255.6 billion

Average total assets = $362.6 billion

Asset turnover ratio = 0.7

Berkshire Hathaway (conglomerate)

Net sales = $245.5 billion

Average total assets = $873.7 billion

Asset turnover ratio = 0.28

Limitations of asset turnover ratio

While the asset turnover ratio can be a useful indicator of a company's efficiency in using its assets to generate sales, it also has some limitations that should be considered when interpreting it.

• Large asset sales or purchases in a given year can skew the average total assets and the net sales data, which in turn can alter the asset turnover ratio.
• Comparing organizations that operate in different marketplaces or have distinct business plans is meaningless because asset turnover ratios can vary dramatically across different industries and sectors.
• The asset turnover ratio ignores factors that can impact a company's performance and value, such as the quality or profitability of the sales the assets create.
• Asset age and condition, which may affect an asset's productivity and efficiency, are not taken into account by asset turnover ratio.

FAQ

The Asset Turnover Ratio is used to understand how effectively a company is using its assets to generate revenue. A higher ratio indicates that the company is using its assets more efficiently to generate sales.

A low Asset Turnover Ratio may indicate that the company is not using its assets efficiently to generate sales. This could be due to poor inventory management, ineffective use of plant, property, and equipment, or other factors.

Yes, the Asset Turnover Ratio can vary significantly across different industries. For example, a capital-intensive industry like manufacturing may have a lower ratio compared to a service industry, which typically requires fewer assets to generate sales.

A company can improve its Asset Turnover Ratio by increasing sales revenue without a corresponding increase in assets, or by reducing its total assets through more efficient operations without a corresponding decrease in sales revenue.