Treasury Practice

Asset turnover ratio

Published: Sep 2008

Turnover ratios measure how effectively something is being used to generate cash. The asset turnover ratio (also known as the total asset turnover ratio) is used to determine the amount of sales that are generated from each euro/dollar/pound of a company’s assets.

The figure can also be used to provide an overview of a company’s pricing strategy. For example, companies operating with a high asset turnover tend to have lower profit margins than those with a low asset turnover.

Asset turnover is calculated using the following formula:

\(\mathrm{Asset\: turnover} = \frac{Sales\: revenue }{Total\:assets}\)
The higher the figure, the more efficiently the company is using its assets. However, the overall level of the ratio will vary from industry to industry.

Example

In 2007 Company A had €1.6m in revenue and total assets of €350,000. By using the formula above, we can determine that Company A’s asset turnover for 2007 was 4.57.

If Company A’s turnover was just €750,000 in 2008 but the company still held €350,000 worth of assets, the asset turnover would only be 2.14.

Interpretation of results

One way of looking at the ratio is to say that in 2007 Company A was able to generate sales of €4.57 for every €1 of assets it owned. Alternatively, it can be interpreted as meaning that Company A’s assets were generated in sales 4.57 times that year.

While a falling asset turnover ratio could indicate that the company is using its assets less efficiently than before, other factors may also need to be taken into account. A falling ratio could simply indicate that the company has recently invested in assets that are not yet generating sales at their full capacity.

Variations

In order to analyse the company’s use of its assets in more detail, the total asset turnover ratio can be divided in two: the fixed asset turnover ratio (calculated as Sales revenue/Fixed assets) and current asset turnover ratio (calculated as Sales revenue/Current assets).

Another related ratio is the assets to sales ratio, which is calculated as Total assets/Sales revenue – the inverse of the asset turnover ratio. This is used to calculate the amount of assets needed to produce one euro (or equivalent) of sales.

Considerations

A number of factors should be taken into consideration when using this ratio. For example:

  • Different industries are associated with different typical ratios, so care should be taken when using the ratio as a benchmark.
  • The relationship between assets and sales generated will vary over time. For example, the purchase of a major asset will bring down the asset turnover ratio and it may take time for the asset to be used to generate sales.
  • Conversely, while it may demonstrate that assets are being used efficiently, a high ratio could also indicate that the company’s assets were purchased some time ago and have depreciated in value.

Asset turnover provides a glimpse into the total success – or otherwise – of a particular company. It should always be used in conjunction with other information to give an accurate overview of the company’s performance.

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