Asset Turnover

Asset management (turnover) ratios Print Email

Definition

Asset turnover (total asset turnover) is a financial ratio that measures the efficiency of a company's use of its assets to product sales. It is a measure of how efficiently management is using the assets at its disposal to promote sales. The ratio helps to measure the productivity of a company's assets.

Asset Turnover Calculation (Formula)

or in days = 365 / Asset turnover

where:

• Revenue refers to the total sales revenue generated by the company over a given period, such as a year.
• Average total assets refer to the average value of all of the company's assets over the same period, which is calculated by adding the beginning and ending asset balances for the period and dividing by two.

For example, if a company generates \$1,000,000 in revenue over a year and has an average total asset balance of \$500,000, the asset turnover ratio would be calculated as:

Asset turnover = \$1,000,000 / \$500,000 = 2

This means that for every dollar of assets, the company is generating \$2 in revenue. A higher asset turnover ratio is generally seen as a positive sign, as it indicates that the company is generating more revenue from its assets and is using its resources more efficiently. However, it's important to consider asset turnover in conjunction with other financial metrics and qualitative factors to get a more complete picture of the company's financial health.

The numerator of the asset turnover formula shows revenues which are found on a company's income statement (statement of comprehensive income) and the denominator shows total assets which is found on a company's balance sheet (statement of financial position).

Can asset turnover be negative? The asset turnover ratio is calculated by dividing revenue by average total assets, and revenue is always a positive number. So the ratio can't be negative.

Asset Turnover Ratio Normal Value and Industry Benchmark

There is no single number that represents a good total asset turnover ratio, because each industry has different business models. It also depends on the ratio of labor costs to capital required, i.e. whether the process is labor intensive or capital intensive.

The higher the number, the better. A low turnover may indicate that the company should either use its assets more efficiently or sell them. But it also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.

If a company's asset turnover ratio is very low or approaching zero, it may indicate that the company is not generating sufficient revenue to justify the level of investment in its assets. In this case, the focus should be on improving revenue generation and increasing the efficiency of asset utilization. However, it's important to note that a low asset turnover ratio does not necessarily mean that a company is performing poorly, as some industries or business models may require a higher level of investment in assets to generate revenue.

It should be noted that the asset turnover ratio formula does not look at how well a company is earning profits relative to assets. The asset turnover ratio formula only looks at revenues and not profits. This is the distinct difference between return on assets (ROA) and the asset turnover ratio, as return on assets looks at net income, or profit, relative to assets.

You can find industry benchmarks for asset turnover in our reference book.

How to Improve Asset Turnover?

Improving asset turnover requires a company to focus on increasing revenue generated by its assets or reducing the value of its assets while maintaining or increasing revenue. Here are a few strategies that a company can use to improve its asset turnover:

1. Increase sales.

One of the most direct ways to improve asset turnover is to increase sales revenue. This can be achieved through various strategies such as expanding the customer base, launching new products or services, increasing marketing efforts, or improving the sales process.

2. Improve pricing strategy.

Adjusting prices can help to boost sales volume and revenues. The company can consider adopting a more competitive pricing strategy, offering discounts, or introducing volume-based discounts for bulk purchases.

3. Optimize inventory.

Managing inventory levels effectively can help reduce the value of assets without affecting sales revenue. By improving forecasting and inventory management processes, a company can reduce excess inventory, avoid stockouts, and improve the speed of inventory turnover.

4. Sell underperforming assets.

If certain assets are not generating revenue or are underperforming, it may be wise to sell them to reduce the value of the company's assets. This can free up resources to invest in more profitable areas of the business.

5. Streamline operations.

A company can improve its asset turnover by improving operational efficiency. This can include optimizing production processes, reducing waste and inefficiencies, and automating manual tasks. By streamlining operations, a company can reduce the amount of resources required to generate revenue.

A corporation must approach its business operations holistically and concentrate on finding methods to make more money with fewer assets if it wants to increase asset turnover. A corporation may increase asset turnover, increase efficiency, and increase profitability by putting these techniques into practice.