Average total assets are found by taking the average of the beginning and ending assets of the period being analyzed. The standard asset turnover ratio considers all asset classes including current assets, long-term assets, and other assets. To get a true sense of how well a company’s assets using the information shown here, which of the following is the asset turnover ratio? are being used, it must be compared to other companies in its industry. For instance, a ratio of 1 means that the net sales of a company equals the average total assets for the year. In other words, the company is generating 1 dollar of sales for every dollar invested in assets.
By dividing the number of days in the year by the asset turnover ratio, an investor can determine how many days it takes for the company to convert all of its assets into revenue. The asset turnover ratio is most helpful when compared to that of industry peers and tracking how the ratio has trended over time. Irrespective of whether the total or fixed variation is used, the asset turnover ratio is not practical as a standalone metric without a point of reference. Next, a common variation includes only long-term fixed assets (PP&E) in the calculation, as opposed to all assets.
Interpretation of the Asset Turnover Ratio
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. A system that began being used during the 1920s to evaluate divisional performance across a corporation, DuPont analysis calculates a company’s return on equity (ROE). We now have all the required inputs, so we’ll take the net sales for the current period and divide it by the average asset balance of the prior and current periods. To reiterate from earlier, the average turnover ratio varies significantly across different sectors, so it makes the most sense for only ratios of companies in the same or comparable sectors to be benchmarked. As with all financial ratios, a closer look is necessary to understand the company-specific factors that can impact the ratio.
Just-in-time (JIT) inventory management, for instance, is a system whereby a firm receives inputs as close as possible to when they are actually needed. So, if a car assembly plant needs to install airbags, it does not keep a stock of airbags on its shelves, but receives them as those cars come onto the assembly line. For every dollar in assets, Walmart generated $2.30 in sales, while Target generated $2.00. Target’s turnover could indicate that the retail company was experiencing sluggish sales or holding obsolete inventory. The asset turnover ratio uses the value of a company’s assets in the denominator of the formula. To determine the value of a company’s assets, the average value of the assets for the year needs to first be calculated.
Formula and Calculation of the Asset Turnover Ratio
Companies with fewer assets on their balance sheet (e.g., software companies) tend to have higher ratios than companies with business models that require significant spending on assets. While the asset turnover ratio should be used to compare stocks that are similar, the metric does not provide all of the detail that would be helpful for stock analysis. It is possible that a company’s asset turnover ratio in any single year differs substantially from previous or subsequent years. Investors should review the trend in the asset turnover ratio over time to determine whether asset usage is improving or deteriorating. The asset turnover ratio is expressed as a rational number that may be a whole number or may include a decimal.
- For Year 1, we’ll divide Year 1 sales ($300m) by the average between the Year 0 and Year 1 PP&E balances ($85m and $90m), which comes out to a ratio of 3.4x.
- Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
- On the flip side, a turnover ratio far exceeding the industry norm could be an indication that the company should be spending more and might be falling behind in terms of development.
- One variation on this metric considers only a company’s fixed assets (the FAT ratio) instead of total assets.
- Comparisons are only meaningful when they are made for different companies within the same sector.
- While the asset turnover ratio considers average total assets in the denominator, the fixed asset turnover ratio looks at only fixed assets.
Sally’s Tech Company is a tech start up company that manufactures a new tablet computer. Sally is currently looking for new investors and has a meeting with an angel investor. The investor wants to know how well Sally uses her assets to produce sales, so he asks for her financial statements. Net sales, found on the income statement, are used to calculate this ratio returns and refunds must be backed out of total sales to measure the truly measure the firm’s assets’ ability to generate sales.
Analysis
To calculate the ratio in Year 1, we’ll divide Year 1 sales ($300m) by the average between the Year 0 and Year 1 total asset balances ($145m and $156m). The ratio is meant to isolate how efficiently the company uses its fixed asset base to generate sales (i.e., capital expenditures). Company A reported beginning total assets of $199,500 and ending total assets of $199,203. Over the same period, the company generated sales of $325,300 with sales returns of $15,000. The asset turnover ratio may be artificially deflated when a company makes large asset purchases in anticipation of higher growth.
Though ABC has generated more revenue for the year, XYZ is more efficient in using its assets to generate income as its asset turnover ratio is higher. XYZ has generated almost the same amount of income with over half the resources as ABC. It is the gross sales from a specific period less returns, allowances, or discounts taken by customers. When comparing the asset turnover ratio between companies, ensure the net sales calculations are being pulled from the same period.
