The asset turnover ratio measures the value of a company’s sales or revenues relative to the value of its assets. The ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue.
The higher the 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.
Equation: Asset Turnover = Total Sales / Average Assets
Typically, the asset turnover ratio is calculated on an annual basis. The higher the ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per pound 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 ratio. Conversely, firms in sectors such as utilities and real estate have large asset bases and low ration.
The asset turnover ratio measures the efficiency of a company’s assets in generating revenue or sales. It compares the amount of sales (revenues) to its total assets as an annualized percentage. Thus, to calculate the ratio, divide net sales or revenue by the average total assets.
Asset turnover ratios vary across different industry 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 ratio. Meanwhile, firms in sectors like utilities or manufacturing tend to have large asset bases, which translates to lower ratio.
A company may attempt to raise a low asset turnover ratio by stocking its shelves with highly moving items, replenishing inventory only when necessary, and augmenting its hours of operation to increase customer foot traffic and spike sales. Just-in-time 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.