What Is Asset Turnover Ratio and How Is It Calculated?

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Businesses are always eager to know if they are profitable. To stay on top of profitability, they will assess ways to improve efficiency, reduce costs, incentivize employees and optimize operations to maximize the bottom line.

One way to measure this metric is to understand a business’s asset turnover ratio. Learn more about what exactly an asset turnover ratio is and how it’s calculated.

Understanding Asset Turnover Calculation 

Every business has assets. These assets are categorized as tangible, intangible and intellectual. 

• Tangible assets may include equipment, vehicles and other property. These are assets that will typically lose value over time. 
• Intangible assets are your business reputation and brand. These are assets you generally cannot touch and would not list on a balance sheet. 
• Intellectual assets are generally things like trademarks, copyrights, domains and software. 

But how do those existing assets generate capital? 

How Do You Define Asset Turnover Ratio?

The asset turnover ratio is a financial metric that evaluates how effectively your business uses its assets to produce revenue. 

The ratio is used to measure the efficiency of your company’s operations. A high ratio shows the company uses its assets well. A low ratio indicates a less than optimal use of existing assets. 

Why the Asset Turnover Ratio Calculation Is Important 

Many metrics measure a business’s profitability. By using this ratio, companies can evaluate their productivity in using assets that are on hand. 

Here are other perspectives on why the asset turnover ratio calculation is key for a company: 

• Identifies inefficiency in a company’s internal process. It could signal a company’s equipment isn’t being used to full capacity. It may also mean a company isn’t collecting receivables in a timely manner or that inventory is obsolete. 
• Assess trends. Having an asset turnover ratio allows a company to see how it is doing compared to previous years. 
• Benchmark performance. The company can do a health check to compare itself with other businesses in the industry. 
• Improve profitability. Analyzing inefficiency offers a company a way to improve its use of assets toward profitability. 

How the Calculation Works 

There is a specific formula used to calculate asset turnover ratio.

Net sales ÷ average total assets

• Net sales: Refers to the revenue earned after subtracting sales returns, discounts and allowances.
• Average total assets: This is the addition of the total number of assets at the beginning of the year plus the total number of assets at the end of the year divided by two. 

Step-by-Step Guide To Calculating Asset Turnover

Step 1: Calculate Your Net Sales

• Net sales are the total amount of revenue generated from selling goods or services, minus any returns, discounts or allowances. This number appears on the company’s income statement.
• Formula for net sales: Net sales = total sales – returns – discounts – allowances

Step 2: Calculate Average Total Assets

• To find average total assets, take the value of the company’s total assets at the beginning of the year and at the end of the year. Divide this by two. These values are usually found on the company’s balance sheet.
• Formula for average total assets: Average total assets = total assets at the beginning of the year + total assets at end of the year ÷ 2

 Step 3: Apply the Asset Turnover Ratio Formula

• Since you have the value of net sales and average total assets, use the following formula: Asset turnover ratio = net sales divided by average total assets. 

Asset Turnover Ratio Example

Assume company Zander has the following numbers:

• Net sales: $125,000
• Total assets at the beginning of the year: $40,000
• Total assets at the end of the year: $80,000

Average total Assets = ($40,000 + $80,000) ÷ 2 = $60,000

Asset turnover ratio = $125,00 ÷ $60,000 = 2

Zander generates an asset turnover ratio of 2. This means it generates $2 for every $1 in asset it uses. 

Analysis of High and Low Ratios

An asset turnover ratio could be high or low. Depending on the industry, a high or low ratio may mean different things. Ratios should generally be compared within an industry. 

A high ratio indicates the following:

• Company is maximizing its use of assets. This may mean a good utilization of assets and an effective operations team.
• Competitive advantage over competitors. A high asset turnover ratio indicates that the company is outperforming other competitors. 
• Potential for higher profitability. There is always the chance of increased profitability in the future. 

A low ratio indicates the following: 

• Company is using its resources inefficiently. A low turnover ratio indicates that the company may not be effectively using its resources. 
• Lower sales in performance. A lack of healthy sales is also a hallmark of a lower asset turnover ratio.  
• Potentially profitability concerns. A lower turnover ratio indicates profitability may be an issue in the future. 

Influencing Factors on Asset Calculation

Several factors impact how companies calculate and interpret their asset turnover ratio. These factors can vary by industry and company.

Industry Level

The type of industry a company operates in affects its asset turnover ratio. Different industries have varying levels of capital intensity, which directly impacts how assets are used to drive revenue.

For example, retail companies generally have higher asset turnover ratios because they sell products quickly and need fewer assets to generate sales. In contrast, industries like real estate, manufacturing and utilities often have lower asset turnover ratios. These fields rely heavily on infastructure and machinery, which can slow down asset turnover.

Company Level

At the company level, internal factors can influence asset turnover ratio. One of the prime drivers is how efficient a company is in maximizing their assets and managing inventory. Operational and management strategies will influence these metrics.

For example, a company that invests in technology or AI may find that they can streamline production to improve asset turnover. In contrast, a company that overinvests in underperforming assets will see how it adversely impacts the asset turnover ratio.

Final Take

The asset turnover ratio is a valuable financial metric that measures a company’s efficiency in using its assets to generate revenue. By understanding this ratio, you can gain insights into a company’s effectiveness in using its assets to drive sales. 

A high asset turnover ratio indicates effective asset utilization, which often translates to higher profitability. Conversely, a low ratio may signal inefficiencies or the need for strategic changes. However, it’s important to consider industry norms when evaluating this ratio, as asset utilization varies significantly across sectors.

Takeaway

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