What Is the Asset Turnover Ratio?
The asset turnover ratio measures the value of a company's sales or revenuesrelative to the value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue.
The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets. Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to generate sales.
Key Takeaways
- Asset turnover is the ratio of total sales or revenue to average assets.
- This metric helps investors understand how effectively companies are using their assets to generate sales.
- Investors use the asset turnover ratio to compare similar companies in the same sector or group.
- A company's asset turnover ratio can be impacted by large asset sales as well as significant asset purchases in a given year.
:max_bytes(150000):strip_icc()/Assetturnover-6ea63bd69a8e4cb5a6bdf5fdfc56576a.jpg "Asset Turnover Ratio Definition (1)")
Formula and Calculation of the Asset Turnover Ratio
Below are the steps as well as the formula for calculating the asset turnover ratio.
AssetTurnover=2BeginningAssets+EndingAssetsTotalSaleswhere:TotalSales=AnnualsalestotalBeginningAssets=AssetsatstartofyearEndingAssets=Assetsatendofyear
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.
- Locate the value of the company's assets on the balance sheet as of the start of the year.
- Locate the ending balance or value of the company's assets at the end of the year.
- Add the beginning asset value to the ending value and divide the sum by two, which will provide an average value of the assets for the year.
- Locate total sales—it could be listed as revenue—on the income statement.
- Divide total sales or revenue by the average value of the assets for the year.
What the Asset Turnover Ratio Can Tell You
Typically, the asset turnover ratio is calculated on an annual basis. The higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets.
The asset turnover ratio tends to be higher for companies in certain sectors than in others. Retail and consumer staples, for example, have relatively small asset bases but have high sales volume—thus, they have the highest average asset turnover ratio. Conversely, firms in sectorssuch as utilities and real estate have large asset bases and low asset turnover.
Since this ratio can vary widely from one industry to the next, comparing the asset turnover ratios of a retail company and a telecommunications company would not be very productive. Comparisons are only meaningful when they are made for different companies within the same sector.
Example of How to Use the Asset Turnover Ratio
Let's calculate the asset turnover ratio for four companies in the retail and telecommunication-utilities sectors for FY 2020—Walmart Inc. (WMT), Target Corporation (TGT), AT&T Inc. (T), and Verizon Communications Inc. (VZ).
| Asset Turnover Examples | ||||
|---|---|---|---|---|
| ($ Millions) | Walmart | Target | AT&T | Verizon |
| Beginning Assets | 219,295 | 42,779 | 551,669 | 291,727 |
| Ending Assets | 236,495 | 51,248 | 525,761 | 316,481 |
| Avg. Total Assets | 227,895 | 47,014 | 538,715 | 304,104 |
| Revenue | 524,000 | 93,561 | 171,760 | 128,292 |
| Asset Turnover | 2.3x | 2.0x | 0.32x | 0.42x |
AT&T and Verizon have asset turnover ratios of less than one, which is typical for firms in the telecommunications-utilities sector. Since these companies have large asset bases, it is expected that they would slowly turn over their assets through sales.
Clearly, it would not make sense to compare the asset turnover ratios for Walmart and AT&T, since they operate in very different industries. But comparing the relative asset turnover ratios for AT&T compared with Verizon may provide a better estimate of which company is using assets more efficiently in that industry. From the table, Verizon turns over its assets at a faster rate than AT&T.
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 holdingobsolete inventory.
Furthermore, its low turnover may also mean that the company has lax collection methods. The firm's collection period may be too long, leading to higheraccounts receivable. Target, Inc. could also not be using its assets efficiently: fixed assetssuch as property or equipment could be sitting idle or not being utilized to their full capacity.
Using the Asset Turnover Ratio With DuPont Analysis
The asset turnover ratio is a key component ofDuPont analysis, a system that the DuPont Corporation began using during the 1920s to evaluate performance across corporate divisions. The first step of DuPont analysis breaks downreturn on equity(ROE) into three components, one of which is asset turnover, the other two beingprofit margin,andfinancial leverage. The first step of DuPont analysis can be illustrated as follows:
ROE=ProfitMargin(RevenueNetIncome)×AssetTurnover(AARevenue)×FinancialLeverage(AEAA)where:AA=AverageassetsAE=Averageequity
Sometimes, investors and analysts are more interested in measuring how quickly a company turns its fixed assets or current assets into sales. In these cases, the analyst can use specific ratios, such as the fixed-asset turnover ratio or the working capital ratio to calculate the efficiency of these asset classes. The working capital ratio measures how well a company uses its financing from working capital to generate sales or revenue.
The Difference Between Asset Turnover and Fixed Asset Turnover
While the asset turnover ratio considers average total assets in the denominator, the fixed asset turnover ratio looks at only fixed assets. The fixed assetturnover ratio(FAT) is, in general, used by analysts to measure operating performance. This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures a company's ability to generate net sales from its fixed-asset investments, namelyproperty, plant, and equipment(PP&E).
The fixed asset balance is a used net of accumulated depreciation. Depreciation is the allocation of the cost of a fixed asset, which is spread out—or expensed—each year throughout the asset's useful life. Typically, a higher fixed asset turnover ratio indicates that a company has more effectively utilized its investment in fixed assets to generate revenue.
Limitations of Using the Asset Turnover Ratio
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 may be artificially deflated when a company makes large asset purchases in anticipation of higher growth. Likewise, selling off assets to prepare for declining growth will artificially inflate the ratio. Also, many other factors (such as seasonality) can affect a company's asset turnover ratio during periods shorter than a year.
What Is Asset Turnover Measuring?
Theasset turnover ratiomeasures the efficiency of a company'sassetsin generating revenue or sales. It compares the dollar amount of sales (revenues)to its total assets as an annualized percentage. Thus, to calculate the asset turnover ratio, divide net sales or revenue by the average total assets. One variation on this metric considers only a company's fixed assets (the FAT ratio) instead of total assets.
Is It Better to Have a High or Low Asset Turnover?
Generally, a higher ratio is favored because it implies that the company is efficient in generating sales or revenues from its asset base. A lower ratio indicates that a company is not using its assets efficiently and may have internal problems.
What Is a Good Asset Turnover Value?
Asset turnover ratios vary across differentindustry sectors, so only the ratios of companies that are in the same sector should be compared. For example, retail or service sector companies have relatively small asset bases combined with high sales volume. This leads to a high average asset turnover ratio. Meanwhile, firms in sectors like utilities or manufacturing tend to have large asset bases, which translates to lower asset turnover.
How Can a Company Improve Its Asset Turnover Ratio?
A company may attempt to raise a low assetturnover ratioby stocking its shelves with highly salable items, replenishinginventoryonly when necessary, and augmenting its hours of operation to increase customer foot traffic and spike sales. 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.
Can Asset Turnover Be Gamed by a Company?
Like many other accounting figures, a company's management can attempt to make its efficiency seem better on paper than it actually is. Selling off assets to prepare for declining growth, for instance, has the effect of artificially inflating the ratio. Changing depreciation methods for fixed assets can have a similar effect as it will change the accounting value of the firm's assets.
The Bottom Line
The asset turnover ratio is a metric that compares revenues to assets. A high asset turnover ratio indicates a company that is exceptionally effective at extracting a high level of revenue from a relatively low number of assets. As with other business metrics, the asset turnover ratio is most effective when used to compare different companies in the same industry.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
Walmart. "2020 Annual Report."
Target. "2020 Annual Report."
AT&T Inc. "2020 Annual Report."
Verizon. "Annual Report 2020."
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As an expert in financial analysis and ratios, I have a comprehensive understanding of the asset turnover ratio and its implications for evaluating a company's efficiency in utilizing its assets to generate revenue. My knowledge is rooted in both theoretical concepts and practical applications, allowing me to interpret the significance of the asset turnover ratio in diverse industry contexts.
Asset Turnover Ratio Overview:
The asset turnover ratio is a vital financial metric that measures a company's ability to generate sales or revenue in relation to its total assets. The formula for calculating the asset turnover ratio involves dividing total sales by the average value of assets over a specific period. This ratio serves as a key indicator of operational efficiency, with a higher ratio suggesting effective asset utilization.
Formula and Calculation:
The formula for the asset turnover ratio is expressed as follows:
[ \text{Asset Turnover} = \frac{\text{Total Sales}}{\frac{\text{Beginning Assets} + \text{Ending Assets}}{2}} ]
Where:
- (\text{Total Sales}) refers to the annual sales total.
- (\text{Beginning Assets}) represents the assets at the start of the year.
- (\text{Ending Assets}) represents the assets at the end of the year.
The average value of assets is determined by adding the beginning asset value to the ending value and dividing the sum by two.
Interpreting the Asset Turnover Ratio:
A higher asset turnover ratio implies better performance, indicating that the company efficiently converts its assets into revenue. Different industries may have varying average asset turnover ratios, making it crucial to compare ratios within the same sector for meaningful insights.
Example Analysis:
To illustrate, consider the asset turnover ratios for Walmart, Target, AT&T, and Verizon in FY 2020. Walmart and Target, operating in the retail sector, exhibit higher asset turnover ratios compared to AT&T and Verizon in the telecommunications-utilities sector. This discrepancy is expected due to the nature of their respective industries.
Integration with DuPont Analysis:
The asset turnover ratio plays a significant role in DuPont analysis, a comprehensive framework for evaluating return on equity (ROE). In DuPont analysis, ROE is broken down into three components: profit margin, asset turnover, and financial leverage.
Comparison with Fixed Asset Turnover:
It's crucial to distinguish between the asset turnover ratio and the fixed asset turnover ratio, which focuses specifically on fixed assets. The fixed asset turnover ratio evaluates a company's ability to generate net sales from its investments in property, plant, and equipment.
Limitations and Considerations:
While the asset turnover ratio is a valuable metric, it has limitations. Comparisons should be made within the same industry, and trends over time should be analyzed. Large asset sales or purchases can distort the ratio, requiring careful interpretation.
In conclusion, the asset turnover ratio is a powerful tool for assessing a company's operational efficiency and revenue generation capabilities. When used in conjunction with other financial metrics and analyses, it provides a holistic view of a company's financial health and performance.
