Asset Turnover Ratio:
Assets Turnover Ratio is used to understand how well the company uses its total assets to generate sales year on year, thus while calculating the assets turnover ratio the average assets are taken to arrive at real assets in use during the year to generate specified sales.
If your question is what is a good asset turnover ratio? Then answer is simple higher the ratio compared to industry standards is a good ratio, it means the company utilize its assets in a better way than competitors and generate more sales agonist total assets deployed. This ratio needs to be seen in comparison to nature of business the company operates into whether it’s a asset heavy business or asset light business model. Along with life of assets against its ability to support sales in assets lifespan.
How do you calculate asset turnover Ratio:
First step is to take net sales for the year from companies’ financial statements, you may need to deduct items like sales returns if they are reflecting in the financial statements from total or Gross Sales to arrive at a Net Sales. Next step is to calculate average total assets do to so we take total assets of the company from financial statements which are at the beginning of the year and total assets at the end of the year and divide the figure by two to arrive at average total assets for the year. Finally, divide Net Sales during the year by average assets.
Return on assets formula = Net Sales / Average Total Assets
Formula to calculate Average total assets = Assets at the beginning of the year + Assets at the end of the year / 2
Meaning of Hight Asset Turnover ratio: It means company is efficiently using its assets to generate sales revenue. In other words, companies inventory management is robust and has a high turnover ratio along with use of fixed assets to generate sales is good and capacity utilization is better. To analyse how better the Assets are used you need to take two or three companies in a similar business and compare their Asset turnover ratio. It important you choose companies for comparison carefully giving due importance to there target markets, company size, products and even target customers all matters. Reason being for example ice cream manufacturing companies with United States as target market may have different target customers from Elite Brand to General Brand to B2B supplies, in such a scenario the cost of equipment to produce acceptable quality and generate sales based on various credit terms may vary. Once done with identical competitor’s selection its far easy and superior to analysis Assets Turnover Ratio for last three years to draw a actionable insight towards company’s efficiency to generate higher sales against assets deployed.
On the other hand, is the company has low asset turnover ratio compared to its peers it is likely that the inventory turnover ratio is higher and fixed assets may not be utilized to its full capacity, and management efficiency is poor.
Company XYZ has reported a Gross Sales of $10M for the year ending 2017, which sales returns of $.05M. The Total Assets at the beginning of the year ware $8M and Total Assets at the End of the Year are $10M.
Company XYZ Asset Turnover Ratio = (10-0.5) / ((8+10)/2) = 1.05 times.
It means the Company generates 1.05 times the sales against its assets i.e. for every one dollar invested the company generates 1.05 dollars as revenue.