Asset turnover ratio

Definition

The asset turnover ratio is a financial metric used to evaluate a company’s efficiency in generating revenue from its assets.

What is the asset turnover ratio?

The asset turnover ratio measures how effectively a company utilises its assets to generate sales or revenue. 

This ratio is calculated using the following formula:

Asset turnover ratio = net sales or revenue / average total assets

It indicates how much revenue is generated for every dollar invested in assets.

The adequacy of the asset turnover ratio can vary significantly by industry. Different industries have different asset revenue norms, so it’s important to compare a company’s ratio to that of its peers.

A high ratio may suggest that the company is effectively using its assets to generate sales, which is generally viewed positively. However, an extremely high ratio might indicate underutilised assets. Conversely, a low ratio could indicate inefficient use of assets, which may be a concern for investors and creditors.

Investors look at this ratio to understand the company’s operational efficiency and effectiveness in utilising its resources. It can impact stock prices and influence investment decisions.

Limitations of the asset turnover ratio

While the asset turnover ratio is valuable, it’s important to consider industry-specific factors and other financial metrics for a comprehensive evaluation of a company’s operational efficiency. It can be skewed by factors such as seasonal fluctuations or significant one-time events, which may distort the true efficiency of asset use. Additionally, it focuses solely on revenue generation, overlooking profitability and cost management. The ratio also does not differentiate between old and new assets, potentially disadvantaging companies with older, fully depreciated assets.

Asset turnover vs. fixed asset turnover

Asset turnover and fixed asset turnover are both efficiency ratios, but they focus on different aspects. Asset turnover measures how efficiently a company uses its total assets to generate sales, calculated by dividing sales by total assets. It provides a broad view of overall asset utilisation. Fixed asset turnover, on the other hand, specifically evaluates how well a company uses its fixed assets, such as property, plant, and equipment, to generate sales. It is calculated by dividing sales by fixed assets. While asset turnover gives an overview of all assets, fixed asset turnover offers insights into the efficiency of long-term investments.

Example of asset turnover ratio

1. Financial information:
   • ABC Retail has the following financial information for the year:
     • Net sales: £1,500,000
     • Beginning total assets: £800,000
     • Ending total assets: £1,200,000
2. Calculation of asset turnover ratio:
   • The asset turnover ratio is calculated as: ​
     Average total assets = (£800,000 + £1,200,000) / 2
     Asset turnover ratio = £1,500,000 / £1,200,000 = 1,5

   The asset turnover ratio for ABC Retail is 1.5, indicating that, on average, the company generates £1.50 in sales for every £1 of assets.