How to Use the Total Asset Turnover Formula (With Examples)
By Indeed Editorial Team
Updated September 15, 2022
Published November 24, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
One factor that may influence the success of a company is the amount of working capital it can access. The company's working capital refers to the total revenue flow and the assets the company uses to cover the operational cost. An asset turnover ratio can help you evaluate how well a company uses its assets to generate income. In this article, we learn what the asset turnover formula is and how to calculate it, discuss what makes for a good ratio and how industries affect companies' ratios and review an example of asset turnover ratio estimation.
What is the asset turnover formula?
The asset turnover formula is the mathematical rule used to calculate a total asset turnover ratio. An asset turnover ratio, also called the total asset turnover ratio, is an efficiency ratio that compares the value of a company's sales income to its total asset value. This ratio is often a significant indicator of how well the company uses its assets to generate income. Here is the formula to calculate an asset turnover:
Asset turnover ratio = net sales / average total assets
In this formula, the elements can read as follows:
Net sales: This is the amount of income generated by the company after making deductions, such as sales tax, sales returns, sales discounts and sales allowances.
Average total assets: This is the average of all assets the company owned at the beginning and end of the fiscal year.
How to calculate asset turnover ratio
There are five steps involved in calculating the asset turnover ratio. These steps include:
1. Get the values of the company's assets
Typically, the first step is getting the values of the organization's assets at the beginning of the trading year and at the end of the trading year. You can access this information on the company's balance sheet. A business asset is an item of value owned by a company. These can be tangible items, such as vehicles, buildings and furniture, or they can be intangible items, such as intellectual property.
2. Obtain the average value of the company's assets
You can sum up both values and divide them by two. The new value obtained is the average value of the company's assets for a year. A company's balance sheet may inform the average value of assets maintained over an accounting period.
3. Calculate the asset turnover ratio
You can start by obtaining the value of the total sales made by the company for that trading year and make the necessary deductions. It can also appear as total revenue on the company's income statement. Then you can divide the total sales by the average asset value of the trading year using the asset turnover formula.
What makes for a high asset turnover ratio?
Accountants and evaluators typically use the asset turnover ratio as an economic measure to determine which company performs better financially. The ratio differs across various industries. A high ratio value often indicates that the company is effectively using its assets.
Typically, companies calculate the total asset turnover ratio per year. They can calculate it based on a shorter or longer period where necessary. Generally, the asset turnover ratio heavily depends on time. For example, if you want to find out the turnover ratio for one month, you may calculate the turnover ratio for a year and divide the value by twelve. There are several reasons a company may have a high asset turnover ratio. Some of them include:
The company produces a supply matching the demand for its product or service.
The company keeps a proper inventory of its assets and sales and can make accurate calculations.
The company generates enough income from its asset base.
The company can navigate through unforeseen economic circumstances like increased competition.
The company's investment in its asset base is at a level that it can maintain.
Does a company's industry impact its asset turnover ratio?
It's essential to understand that asset turnover ratios can vary significantly between separate industries. The peculiarities associated with a company's sector may determine how much asset turnover ratio it produces. For instance, retail enterprises typically have smaller asset bases but significantly larger sales volumes, implying that they may have a much higher asset turnover ratio. In contrast, construction and real estate companies usually have substantial asset bases, which may cause a lower overall asset turnover ratio.
As the total asset turnover ratio differs between businesses, there's no universally established figure for a good asset turnover ratio. Comparing asset turnover ratios across industries may not provide conclusive results. Comparisons are only significant when made among different businesses within the same industry. In the retail industry, a company may view a ratio of 2.5 or above as favourable, but a company in the utility service industry is usually likely to strive for a ratio of 0.25 to 0.5.
What factors can influence a company's asset turnover ratio?
Several factors can influence the value of a company's asset turnover ratio. Some of these factors are:
Properly documented company information can result in a more accurate turnover ratio. Keeping timely and well-documented company records may help ensure that there are no inconsistencies between values and important statistics. Instances like proper tax calculations, adequate sales records and accurate asset inventories can influence the value of the asset turnover ratio.
Unpredictable economic situations may also influence the final turnover value. An instance of such a situation is seasonality. Companies may be unable to turn in huge income when public holidays or celebrations cut the trading year.
Change in sales strategy
When the company makes a drastic sales change, it may affect the turnover ratio. For example, when the company makes an asset purchase to prepare for expansion, the turnover ratio may decrease. If the company sells off a vast portion of its assets in preparation for a declining season, the turnover ratio may increase.
How does asset turnover ratio differ from fixed asset turnover?
While the asset turnover ratio considers average overall assets in the denominator, the fixed asset turnover ratio considers only fixed assets. Valuation analysts typically use the fixed asset turnover ratio (FAT) to assess operating performance. Companies apply the fixed asset balance in relation to accumulated depreciation. Generally, a higher fixed asset turnover ratio shows that a business has made better use of its fixed-asset investment to create income.
How can companies improve their total asset turnover ratio?
Companies may improve their asset turnover ratio by doing the following:
Companies can increase their income by utilizing their assets in efficient ways. Doing this may lead to revenue increase, which can improve the asset turnover ratio. For example, the company can put low-priority assets to use and innovate around market constraints.
Leasing of high-maintenance assets
Companies can lease or sell assets that are high maintenance, which means properties that are expensive to maintain but may not yield commensurate value. When specific assets are no longer valuable, the company may sell or lease those properties to offset operational costs. They may increase revenue flow, reduce expenses and grow their asset turnover ratio.
Investment in automation
Technology can help companies automate low-priority tasks. It can make management more seamless and allow different departments within the company to share information promptly. Employees can channel their attention to building better strategies around asset usage and income generation when all the necessary departments communicate efficiently.
Accurate information can make it easier for the company's accounting team to evaluate the asset turnover ratio. When a company documents information in a timely and efficient manner, it can perform accurate calculations and determine its efficiency. Working with the correct information can help produce a more reliable ratio or figure.
Example of asset turnover ratio calculation
Here is an example of how to calculate the asset turnover ratio of a company:
“Acme Manufacturing is an Ontario-based company that manufactures paper straws. The company increased its assets by 100%. This fiscal year Acme generated more sales revenue than last year and fewer sales returns. Using the asset turnover formula, the company's accounting team calculates the asset turnover ratio of the organization:
Total assets at the beginning of the trading year: $50,000
Total assets at the end of the fiscal year: $100,000.
Sales revenue: $30,000
Sales returns: $5,000
Formula: 0.33 = ($30,000 - $5,000) / ($50,000 + $100,000 / 2) = $25,000 / $75,000
The asset turnover ratio of Acme is 0.33. For every dollar in assets, the company generates 33 cents."
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