Asset Turnover Ratio

Asset Turnover Ratio: What It Is and What It Represents

What is an asset turnover ratio?

The asset turnover ratio measures a company’s potential to generate revenue based on the value of its assets. The asset turnover ratio is an indicator of how well a company is using its assets to generate revenue.

An asset is any item with monetary value that a company owns and can be used to generate revenue. This includes cash, accounts receivable, inventory, property, and equipment.

Why should companies calculate their asset turnover ratio?

The asset turnover ratio is usually calculated annually. A high asset turnover ratio means a company is successfully generating revenue through the sale of its assets. 

To calculate the asset turnover ratio, first, you calculate the average value of the asset by dividing the sum of the value of the asset at the beginning and end of the year by two. 

Next, you divide the net sales of the assets by the average you calculated earlier. This gives you the asset turnover ratio for the company for the year. You can find the value of the assets in the balance sheet and the sales in the income statement. 

Asset turnover ratio = Net sales / Average total assets

Retail and consumer goods companies typically have a high asset turnover ratio. Utility companies, on the other hand, have low asset turnover ratios as they have larger asset bases (assets that determine the value of a company). That is, utility companies do not use their assets for the purpose of sale in the same way that retail and consumer goods companies do. So, to understand if a company is doing well in terms of asset turnover, you need to compare businesses in the same sector. 

Asset turnover vs. fixed asset turnover

The asset turnover ratio measures the value generated by the total number of assets whereas fixed asset turnover only measures how fixed assets are generating revenue. Fixed assets are needed for the operation of the business and its long-term good financial health. They include property, plant, and equipment – like buildings, equipment, and transportation vehicles.

Things to look out for

The asset turnover ratio is used for several asset comparisons, like stocks. But, this may not always provide a reliable picture of how well the company is doing because stock values can vary throughout the year. Investors should look into the asset turnover ratio of the company they wish to buy into over the years to see how its asset utilization and value have changed.

It is possible to manipulate the asset turnover ratio by selling off assets when a company expects a decline. In the same way, a business may buy more assets in a given period of time if it anticipates growth. Many other factors such as the market and the season affect how and how much the assets of a business are used.

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