Asset turnover is a ratio that measures the value of sales generated by a business relative to its average total assets for a given fiscal or calendar year. It is an indicator of how efficient the company is using both the current and fixed assets to produce revenue. Average total assets includes the beginning and ending balance of all the components of a company’s assets namely – current assets, long-term investments, fixed assets, and intangible assets.
For the fiscal year ended December 31, 2015, LSFM company has declared in the financial statements total assets ending balance of $450M while the beginning balance was $400M, having an average asset result of $425M ($400M+$450M/2) for that year. Total revenues reached to as high as $950M generated from its main business activities. Given the figures, the asset turnover was therefore on a rate of 2.23 ($950M/$425M).
Net Sales Revenue or sales revenue is the total amount of revenue either in cash or credit that was produced by efficiently utilizing the resources of a company primarily from its core business activities. This is netted by sales returns, allowances and discounts which are accommodated upon customer’s request and due to some unavoidable circumstances.
Average total assets are economic resources which are annually calculated to determine the total assets utilized in a given period. Total assets included are Cash, Marketable Securities, Accounts receivable, Pre-paid expenses, Long-term investments, Inventory, Fixed assets, and Intangible assets. To calculate for the average total assets, the beginning and ending asset balances are taken into consideration. The figures are then divided in half to get the standard amount of assets owned by the company for a given fiscal or calendar year.
Asset turnover ratio is a good indicator for measuring the health of a business and of how efficient a company is utilizing its assets to generate revenue. The higher the ratio, the better the business is performance-wise. On the other hand, lower ratio may entail a problem with one or more of the asset categories comprising total assets – inventory, receivables, or fixed assets. Obsolete inventory or sluggish sales can affect the numbers. Same with receivables, collection may take too long and credit accounts may pile up. Fixed assets such as property, plant and equipment could be unproductive instead of being put to use to their full capacity. All these categories are closely monitored to ascertain the validity when using asset turnover ratio.