The asset turnover ratio compares the value of a company’s assets to the value of its sales or revenues. The asset turnover ratio is a metric that measures how effectively a corporation uses its assets to produce income.
A company’s ability to generate revenue from its assets is measured by its asset turnover ratio. The higher the asset turnover ratio, the more efficient it is. A low asset turnover ratio, on the other hand, suggests that a corporation is not effectively leveraging its assets to produce sales.
The Asset Turnover Ratio and What It Can Tell You
The asset turnover ratio is usually calculated once a year. The higher the asset turnover ratio, the better the company performs, because higher ratios indicate that the company generates more revenue per dollar of assets.
Companies in particular industries have a greater asset turnover ratio than others. For example, retail and consumer staples have tiny asset bases but high sales volume, resulting in the highest average asset turnover ratio. Companies in sectors like utilities and real estate, on the other hand, have vast asset bases and limited asset turnover.
Comparing the asset turnover ratios of a retail company and a telecoms company would be ineffective because this ratio varies so much from one industry to the next. Comparisons are only useful when they are done between similar companies in the same industry.
Asset Turnover vs. Fixed Asset Turnover: What’s the Difference?
In the denominator, the asset turnover ratio incorporates average total assets, whereas the fixed asset turnover ratio solely considers fixed assets. Analysts commonly utilise the fixed asset turnover ratio (FATR) to assess operating performance.
This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) to determine a company’s capacity to generate net sales from fixed-asset investments, such as property, plant, and equipment (PP&E).
Net of cumulative depreciation, the fixed asset balance is utilised. Depreciation is the process of spreading out the cost of a fixed asset over time, or expensed, during the asset’s useful life. A greater fixed asset turnover ratio typically implies that a corporation has made better use of its fixed asset investment to generate income.
Use of the Asset Turnover Ratio Has Its Limits:
While the asset turnover ratio should be used to compare similar stocks, it does not provide all of the information necessary for stock analysis. A company’s asset turnover ratio in any given year may fluctuate significantly from prior or subsequent years. To evaluate if asset usage is improving or deteriorating, investors should examine the trend in the asset turnover ratio over time.
When a corporation makes substantial asset purchases in anticipation of faster growth, the asset turnover ratio may be artificially deflated. Similarly, selling assets to brace for slowing growth can boost the ratio artificially. During periods shorter than a year, several other factors (such as seasonality) might affect a company’s asset turnover ratio.
What Is Asset Turnover Measuring and Why Is It Important?
The asset turnover ratio assesses a company’s assets’ ability to generate income or sales. As an annualised percentage, it compares the dollar amount of sales (revenues) to the total assets. Divide net sales or revenue by the average total assets to get the asset turnover ratio. Instead of total assets, one variant of this indicator considers only a company’s fixed assets (the FAT ratio).
Is a High or Low Asset Turnover Beneficial?
A greater ratio is generally preferred since it indicates that the company is effective at generating sales or revenues from its asset base. A lower ratio implies that a corporation is not efficiently utilising its assets and may be experiencing internal issues.
What Is a Reasonable Asset Turnover Price?
Because asset turnover ratios change by industry sector, only the ratios of enterprises in the same industry should be compared. Companies in the retail or service sectors, for example, have tiny asset bases but significant sales volumes. As a result, the average asset turnover ratio is high. Meanwhile, companies in industries such as utilities and manufacturing tend to have substantial asset bases, resulting in lower asset turnover.
How may a company’s asset turnover ratio be improved?
A corporation might try to boost its low asset turnover ratio by stocking its shelves with highly salable items, replacing inventory only as needed, and extending its hours of operation to increase customer foot traffic and sales.
For example, just-in-time (JIT) inventory management is a system in which a company receives inputs as close to when they are needed as possible. As a result, if a car assembly facility wants to install airbags, it does not have airbags on hand, but instead receives them as the cars come off the assembly line.
Is it possible for a company to manipulate asset turnover?
A company’s management, like many other accounting figures, can try to make its efficiency appear greater on paper than it truly is. Selling assets to prepare for slowing growth, for example, has the effect of raising the ratio artificially. Changing fixed asset depreciation techniques might have a similar impact on the accounting value of the company’s assets.