What is Asset Turnover?
Asset turnover is a financial ratio that measures the value of revenue generated by a business relative to its average total assets for a given fiscal year. It is an indicator of how efficient the company is at using both current and fixed assets to produce revenue.
Average total assets include the beginning and ending balance of a company’s assets – current assets, long-term investments, fixed assets, and intangible assets.
Formula for Asset Turnover Ratio
Asset Turnover = Net Sales Revenue / Average Total Assets
Example of Asset Turnover
For the fiscal year ended December 31, 2015, LSFM company has declared in its 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 as high as $950M generated from its main business activities.
Given the above figures, the asset turnover was at a rate of 2.23 ($950M/$425M).
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What is Net Sales Revenue?
Net Sales Revenue or sales revenue is the total amount of revenue, either in cash or credit, that was produced by utilizing the resources of a company primarily from its core business activities. This is netted by sales returns, allowances, and discounts that are accommodated upon a customer’s request or due to some unavoidable circumstances.
What are Average Total Assets?
Average total assets are economic resources that are annually calculated to determine the total assets utilized in a given period. Total assets include Cash, Marketable Securities, Accounts receivable, Prepaid expenses, Long-term investments, Inventory, Fixed Assets, and Intangible Assets.
To calculate the average total assets, the beginning and ending asset balances are taken into consideration. The figures are then divided in half to get the average amount of assets owned by the company for a given fiscal or calendar year.
What is the Purpose of the Asset Turnover Ratio?
The asset turnover ratio is a good indicator for measuring the health of a business and how efficient a company is in utilizing its assets to generate revenue. The higher the ratio, the better the business is performance-wise. On the other hand, a lower ratio may indicate a problem with one or more asset categories comprising total assets – inventory, receivables, or fixed assets.
Obsolete inventory or sluggish sales can bloat the numbers. Same with receivables – collections may take too long, and credit accounts may pile up. Fixed assets such as property, plant, and equipment (PP&E) could be unproductive instead of being used to their full capacity.
All these categories should be closely managed to improve the asset turnover ratio.
Video Explanation of Asset Turnover Ratio
Watch this short video to quickly understand the definition, formula, and application of the asset turnover ratio.
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