What is the ratio of asset turnover?
A company’s sales or revenues are compared to the value of its assets using the asset turnover ratio. The asset turnover ratio may be used to gauge how well a business uses its assets to produce income.
The more effectively a corporation uses its assets to generate income, the greater its asset turnover ratio. On the other hand, a corporation is not effectively employing its assets to produce revenue if it has a low asset turnover ratio.
Formula and Calculation of the Asset Turnover Ratio
Below are the steps and the formula for calculating the asset turnover ratio.
Asset Turnover=Total Sales
Beginning Assets + Ending Assets
where: Total Sales=Annual sales total
Beginning Assets=Assets at the start of the year
Ending Assets=Assets at the end of the year
The value of a company’s assets is the denominator in the asset turnover ratio calculation. The average asset value for the year must first be computed to establish the worth of a company’s assets.
- Find the asset worth of the firm on the balance sheet as of the year’s beginning.
- Find the assets’ ending balance or value after the fiscal year.
- The average asset value for the year is calculated by adding the beginning and ending asset values and dividing the result by two.
- Find total sales on the income statement; it may be noted as revenue.
- Subtract the annual average asset value from the total sales or revenue.
What You Can Learn from the Asset Turnover Ratio
The asset turnover ratio is typically computed once a year. Since higher ratios suggest that the firm produces more revenue per dollar of assets, the higher the asset turnover ratio, the better the company functions.
Compared to others, the asset turnover ratio is often greater for businesses in some industries. For instance, retail and consumer staples have the highest average asset turnover ratios, modest asset bases, and strong sales volumes. On the other hand, businesses in industries like utilities and real estate have substantial asset bases and limited asset turnover.
Comparing the asset turnover ratios of a retail firm and a telecoms company would not be particularly fruitful because this ratio might vary significantly between industries. Comparisons are only useful when they are done for several businesses operating in the same industry.
| Asset Turnover Examples | ||||
|---|---|---|---|---|
| ($ Millions) | Walmart | Target | AT&T | Verizon |
| Beginning Assets | 219,295 | 42,779 | 551,669 | 291,727 |
| Ending Assets | 236,495 | 51,248 | 525,761 | 316,481 |
| Avg. Total Assets | 227,895 | 47,014 | 538,715 | 304,104 |
| Revenue | 524,000 | 93,561 | 171,760 | 128,292 |
| Asset Turnover | 2.3x | 2.0x | 0.32x | 0.42x |
A Case Study of the Asset Turnover Ratio in Action
For the fiscal year 2020, let’s determine the asset turnover ratio for four companies in the retail and telecommunications-utilities sectors: Walmart Inc. (WMT), Target Corporation (TGT), AT&T Inc. (T), and Verizon Communications Inc. Asset turnover ratios of less than one, which are typical for businesses in the telecommunications-utilities sector, are found at AT&T and Verizon. Given the size of these corporations’ asset bases, it is anticipated that they will gradually sell off their holdings.
Comparing Walmart and AT&T’s asset turnover ratios would be pointless because their industries differ vastly. However, comparing the relative asset turnover ratios for AT&T and Verizon may give a more accurate indication of which business uses its assets more effectively in that sector. According to the table, Verizon sells its assets more frequently than AT&T.
Walmart generated $2.30 in sales for every dollar of assets, compared to Target’s $2.00. The high turnover at Target may be a sign of slow sales or the presence of out-of-date inventory.
The company’s low turnover could also indicate that its collection procedures are lax. The company may have an excessively long collection period, which would increase accounts receivable. It’s also possible that Target, Inc. is not using its resources best; fixed assets like real estate or equipment might be underutilized or sitting idle.
Using DuPont Analysis and Asset Turnover Ratio
The DuPont Corporation started using this system in the 1920s to assess performance across corporate divisions, and the asset turnover ratio is a crucial part of it. Asset turnover is one of three components of return on equity (ROE) broken down in the first phase of the DuPont analysis, together with profit margin and financial leverage.
The following example illustrates the first step of the DuPont analysis:
ROE=Profit Margin(RevenueNet Income)×Asset Turnover(AARevenue)×Financial Leverage(AEAA)Where:AA=Average assetsAE=Average equity
Sometimes, investors and analysts are more interested in analyzing how quickly a business transforms its fixed or current assets into revenues. In these circumstances, the analyst might utilize specialized ratios, such as the fixed-asset turnover ratio or the working capital ratio, to determine the efficiency of various asset types. The working capital ratio assesses how successfully a corporation uses its funding from working capital to create sales or revenue.
Asset Turnover versus Fixed Asset Turnover: A Comparison
While the asset turnover ratio examines average total assets in the denominator, the fixed asset turnover ratio looks at just fixed assets. Analysts use the fixed asset turnover ratio (FAT) to measure operating performance. This efficiency ratio examines a company’s ability to make net sales from its fixed assets, like property, plant, and equipment (PP&E). It compares net sales from the income statement to fixed assets from the balance sheet.
The fixed asset balance is a utilized net of accumulated depreciation. Depreciation is the allotment of the cost of a fixed asset, which is spread out—or expensed—each year over the asset’s useful life. Typically, a greater fixed asset turnover ratio shows that a corporation has more efficiently utilized its investment in fixed assets to create income.
Limitations of Using the Asset Turnover Ratio
While the asset turnover ratio should be used to compare comparable stocks, the statistic does not give all the data that would benefit stock research. It is conceivable that a company’s asset turnover ratio in any single year varies dramatically from prior or subsequent years. Investors should analyze the trend in the asset turnover ratio over time to assess if asset utilization is improving or decreasing.
The asset turnover ratio may be artificially deflated when a corporation makes big asset purchases in expectation of better growth. Similar to selling off assets to prepare for slowing growth, doing so unnaturally raises the ratio. A variety of additional factors can also impact the asset turnover ratio of a corporation over shorter periods, such as seasonality.
What measures asset turnover?
The asset turnover ratio gauges how well a business’s assets produce income or sales. It computes an annualized percentage comparison between the quantity of sales (revenues) and the total assets. Divide net sales or revenue by the average total assets to determine the asset turnover ratio. The FAT ratio is a variant of this statistic that excludes total assets and only considers fixed assets for a corporation.
Is a high asset turnover or a low asset turnover better?
A greater ratio is often preferred since it suggests the business effectively produces sales or revenues from its asset base. A lower ratio suggests a business is not employing its resources effectively and may be experiencing internal issues.
How Much Should an Asset Turnover Value Be?
Only the ratios of businesses in the same industry sector should be compared because asset turnover ratios change across other industry sectors. For instance, businesses in the retail or service sectors often have limited asset bases and high sales volumes. A high average asset turnover ratio results from this. Companies in industries like manufacturing or utilities often have substantial asset bases, which correlates to reduced asset turnover.
What Can a Business Do to Increase Its Asset Turnover Ratio?
By filling its shelves with highly marketable goods, restocking inventory only when necessary, and extending its hours of operation to draw in more customers and boost sales, a business may try to improve its low asset turnover ratio. A system known as just-in-time (JIT) inventory management, for example, allows a company to receive inputs as near as feasible to the time that they are required. Airbags are thus not kept in stock at a car assembly facility in case they need to be installed; instead, they are delivered when the automobiles are assembled.
Can a Company Trick Asset Turnover?
Like many other accounting metrics, the management of a firm may make an effort to make efficiency appear greater than it is. For example, selling off assets to prepare for slowing growth causes the ratio to be artificially inflated. The accounting value of the company’s assets will vary if the depreciation methodologies for fixed assets are altered.
Revenues and assets are compared using a statistic called the asset turnover ratio. A corporation with a high asset turnover ratio is extraordinarily good at generating a lot of income from a small number of assets. Like other business indicators, the asset turnover ratio works best when compared to several businesses in the same sector.
Conclusion
- The ratio of total sales or revenue to average assets is known as asset turnover.
- Investors can use this measure to gauge how well a company utilizes its resources to drive sales.
- Investors analyze similar businesses in the same industry or group using the asset turnover ratio.
- Both substantial asset sales and purchases can affect a company’s asset turnover ratio in a given year.
