The asset turnover ratio shows the revenue generated by the assets of your business. It is a measure of the efficiency with which the business uses its resources. It is calculated by dividing revenue by assets.
Asset Turnover Ratio Formula
- Assets is given in the balance sheet, it is the total of fixed assets and current assets. It is normal to average the accounting period beginning and ending values of assets.
- Revenue is found in the income statement. It may be called sales or turnover. The amount to include is the revenue net of sales discounts, returns, and allowances.
How to Calculate Total Asset Turnover
Suppose for example fixed assets are 50,000 and current assets are 65,000, the total assets are 115,000. If the revenue generated from these assets is 240,000, then the asset turnover ratio is calculated as follows:
Using the asset turnover ratio formula the calculation is as follows:
Asset turnover ratio = Revenue / Assets Asset turnover ratio = 240,000 / 115,000 Asset turnover ratio = 2.09
In this example the total asset turnover ratio analysis shows that for every 1 invested in assets 2.09 is generated in revenue.
Now suppose for the same investment in assets the business is able to increase the sales to 300,000, by for example utilizing the same assets for a longer period of time throughout the day, then the total assets turnover ratio will increase as follows:
Asset turnover ratio = Revenue / Assets Asset turnover ratio = 300,000 / 115,000 Asset turnover ratio = 2.61
For every 1 invested in assets 2.61 is generated in revenue.
What does the Asset Turnover Ratio show?
The assets turnover ratio shows how efficiently the resources of the business are being used to generate revenue. A low asset turnover ratio could indicate inefficiencies in the assets themselves or in the management team operating them.
All assets of the business should yield their maximum return for the owners, so it is important to monitor any changes in the asset turnover ratio particularly if your business is considering any investment in assets.
The three major components of assets are fixed assets, inventory, and account receivable, so a low asset turnover ratio can imply excess manufacturing capacity if for example fixed assets represent investment in manufacturing facilities, poor inventory control or high accounts receivable and therefore poor credit collection procedures.
Useful tips for using the Asset Turnover Ratio
- The asset turnover ratio will vary from industry to industry, so it is important to make comparisons to similar businesses in your sector. A manufacturing business, for example, would be more capital intensive and therefore all things being equal, have a lower asset turnover ratio than for example a retail business.
- It is possible to improve the asset turnover ratio by for example working shifts. If you own a manufacturing facility and keep it operating throughout the day and night, then manufacturing output and hopefully sales will increase for the same investment in assets
- There is no correct value for the asset turnover ratio, the important thing is to ensure that the trend is upwards to show improving efficiency.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.