The asset turnover ratio compares the worth of a company’s assets to its sales or revenues. The asset turnover ratio is a metric that assesses how efficiently a company uses its assets to generate revenue.
The asset turnover ratio measures a company’s capacity to produce revenue from its assets. The higher the asset turnover ratio, the higher the efficiency. A low asset turnover ratio, on the other hand, indicates that a company is not using its assets efficiently to generate revenue.
What the Asset Turnover Ratio Can Tell You?
Typically, the asset turnover ratio is calculated once a year. Because higher ratios show that the company generates more revenue per dollar of assets, the greater the asset turnover ratio, the better the company performs.
Businesses in certain industries have a higher asset turnover ratio than others. Retail and consumer staples, for example, have small asset bases but high sales volume, resulting in the highest average asset turnover ratio. Companies in industries such as utilities and real estate, on the other hand, have large asset bases with little asset turnover.
Comparing the asset turnover ratios of a retail company and a telecommunications company would be pointless because this ratio varies so greatly between industries. Comparisons are only useful when they are made between companies that are similar in the same industry.
What Is the Difference Between Asset Turnover and Fixed Asset Turnover?
The asset turnover ratio includes average total assets in the denominator, whereas the fixed asset turnover ratio only includes fixed assets. The fixed asset turnover ratio (FATR) is a popular metric used by analysts to analyse operating performance.
This efficiency ratio compares a company’s net sales (income statement) to fixed assets (balance sheet) to measure its ability to generate net sales from fixed-asset investments such as property, plant, and equipment (PP&E).
The fixed asset balance is used after deducting cumulative depreciation. The practice of spreading out the cost of a fixed asset across time, or expensed, during the asset’s useful life is known as depreciation.
A higher fixed asset turnover ratio usually indicates that a company has made better use of its fixed asset investment to produce revenue.
The Asset Turnover Ratio Has Limitations
While the asset turnover ratio is useful for comparing comparable stocks, it does not provide all of the information required for stock analysis. The asset turnover ratio of a corporation in any particular year may differ dramatically from previous or subsequent years.
Investors should monitor the trend in the asset turnover ratio over time to determine whether asset utilisation is improving or decreasing.
When a company purchases large amounts of assets in anticipation of faster expansion, the asset turnover ratio may be artificially deflated. Similarly, selling assets to prepare for slower growth can artificially inflate the ratio. Several other factors (such as seasonality) may alter a company’s asset turnover ratio during periods shorter than a year.
Why Is Asset Turnover Measuring Important?
The asset turnover ratio evaluates the ability of a company’s assets to create income or sales. It compares the monetary amount of sales (revenues) to the total assets as an annualised percentage.
The asset turnover ratio is calculated by dividing net sales or revenue by the average total assets. One form of this indicator evaluates solely a company’s fixed assets rather than total assets (the FAT ratio).
Is it better to have a high or low asset turnover?
A higher ratio is generally desirable because it implies that the company is successful in generating sales or revenues from its asset base. A lower ratio indicates that a company is not utilising its assets efficiently and may be having internal challenges.
What Is a Fair Asset Turnover Price?
Because asset turnover ratios differ by industry sector, only ratios from businesses in the same industry should be compared. Retail and service companies, for example, have small asset bases but large sales volumes. As a result, the asset turnover ratio is on the rise. Meanwhile, corporations in industries like utilities and manufacturing typically have large asset bases, resulting in lower asset turnover.
How may an organization’s asset turnover ratio be improved?
To enhance client foot traffic and revenues, a company may aim to boost its low asset turnover ratio by stocking its shelves with highly salable items, updating inventory only as needed, and extending its hours of operation. Just-in-time (JIT) inventory management, for example, is a system in which a corporation receives inputs as close to when they are required as possible.
As a result, if a car assembly plant wants to install airbags, it does not keep them on hand and must instead order them as the cars come off the assembly line.
Is it possible for a business to influence asset turnover?
Like many other accounting metrics, a company’s management can try to make its efficiency appear better on paper than it is. Selling assets to prepare for slower growth, for example, has the effect of artificially boosting the ratio. Changing fixed asset depreciation methodologies could have a comparable impact on the company’s accounting value.