Asset Turnover Ratios
Asset turnover ratio is the ratio of a company's sales to its assets. It is an efficiency ratio which tells how successfully the company is using its assets to generate revenue.
There are a number of variants of the ratio like total asset turnover ratio, fixed asset turnover ratio and working capital turnover ratio. In all cases the numerator is the same i.e. net sales (both cash and credit) but denominator is average total assets, average fixed assets and average working capital respectively.
Following formulas are used to calculate each of the asset turnover ratios:
|Total Asset Turnover Ratio =||Net Sales|
|Average Total Assets|
|Fixed Asset Turnover Ratio =||Net Sales|
|Average Fixed Assets|
|Working Capital Turnover Ratio =||Net Sales|
|Average Net Working Capital|
If a company can generate more sales with fewer assets it has a higher turnover ratio which tells it is a good company because it is using its assets efficiently. A lower turnover ratio tells that the company is not using its assets optimally. Total asset turnover ratio is a key driver of return on equity as discussed in the DuPont analysis.
As at 1 January 2011 Gamma had total assets of $100, total fixed assets of $60 and net working capital of $20. During FY 2011 it generated sales of $200 with COGS of $160 and its total assets as at 30 December 2011 were $120. During the year it charged depreciation of $10 and there were no fixed asset additions during the year. Current assets and current liabilities were $50 and $30 as at the year end. Calculate total asset turnover, fixed asset turnover and working capital turnover ratios.
Average total assets = (100+120)/2 = $110, sales are $200 so total asset turnover is $200/$110 = 1.82. If the industry average total asset turnover ratio is 1.2 we can conclude that the company has used its asset more effectively in generating revenue.
Opening fixed assets were $60, closing fixed assets are $60-$10=$50. Average fixed assets are hence ($60+$50)/2=$55. This gives us fixed asset turnover of $200/$55 = 3.63
Opening working capital is $20, closing working capital is $20 ($50-$30); this gives us average working capital of $20 and resulting working capital turnover ratio of $200/$20=10.
Asset turnover ratio should be looked at together with the company's financing mix and its profit margin for a better analysis as discussed in DuPont analysis.
Written by Obaidullah Jan, ACA, CFA