Quick Guide: The Asset Turnover Ratio
Our asset turnover calculator is a useful tool to help you calculate how efficiently a company is using its assets to generate sales, but it takes more than just the calculator to use it effectively during your analysis of a company.
In this article we’ll dive into the important details that will help you calculate and use a company’s asset turnover to enhance your financial analysis.
We’ll cover a few main points, including:
- How asset turnover is calculated and what it measures,
- Provide an example to further enhance your understanding of the ratio, and
- What are the characteristics of a good asset turnover ratio.
With the asset turnover calculator and a good understanding of the ratio, you'll have everything you need to effectively and efficiently analyze whether a company is utilizing its assets to generate sales and growth.
How to calculate asset turnover
A company’s asset turnover is calculated by taking revenues during a period and dividing that by the company’s average total assets.
Asset Turnover Ratio Formula = Revenues / Average Total Assets
Average total assets used in the above formula is calculated using the following formula which are found on a company’s balance sheet:
Average Total Assets Formula = (Beginning Assets + Ending Assets) / 2
What does the asset turnover ratio measure?
The asset turnover ratio specifically measures whether a company is using its assets efficiently and effectively to drive higher revenues and increased profits.
This ratio is part of a larger family of financial ratios known as asset management ratios, or efficiency ratios, which measure a company’s overall ability to turn it’s assets into value for shareholders (for more info, check out this post, where we go into asset management ratios in greater detail).
What is a good asset turnover ratio?
Analyzing whether a company has a good asset turnover ratio depends on various factors, including the nature of the company’s operations, the trend of the company’s ratio over time, and how the company measures up to its peer group and industry competitors.
In most cases, the higher the ratio, the better. A higher ratio indicates a company is turning assets into cash flows that help grow the company’s revenue and bottom line.
If a company's ratio is low, or slowing compared to the company’s historical asset turns, that could be an indicator that the company’s investment into capital assets are not generating a strong return.
Remember, an asset is only an asset if it is generating cash flows for the business! Investing in assets that remain idle and don’t grow the business is not a sign of a strong management team.
But, when it comes to evaluating how well company is utilizing its assets, these are only general guidelines.
In order to use this ratio to understand how a company is performing, and use that information to confidently make a decision requires further analysis.
Be sure to check out our post on analyzing financial statement ratios for a deeper dive into understanding a company’s financial statements through financial ratio analysis.
Why not all asset turnover ratios are the same
It’s important to keep a few things in mind when analyzing a company’s asset turnover:
- This ratio can fluctuate depending on the nature of a business’s operations and the industry the business operates in; and
- Because of this, finding the right benchmark to interpret the ratio is very important (and can also be a challenge).
For example, retail stores generally have higher asset turnover, as the business doesn’t require a significant amount of assets to operate effectively.
On a very small scale, think about if you were to start a small boutique clothing shop.
All you would need was enough inventory to stock the shelves, you could then lease a store front, and away you go. The only significant asset required would be the inventory.
But think about this from an industry on the other end of the spectrum. Let’s say a telecommunications company.
Why you might ask?
Because telecommunication companies require a heavy asset load to operate and generate revenue. Think about the amount of equipment, cabling, hardware, etc… it takes for Verizon to build out their wireless network.
None of us could even think about starting a competitor of Verizon because of the investment it would require to build out the assets in order to operate.
Let’s take a look at an example of the asset turnover ratio
To visualize how total asset turnover is calculated, and further understand how two successful companies could have very different ratios, let’s look at Nordstrom and Verizon.
|(in $USD millions)||Nordstrom Inc||Verizon Communications Inc|
|Average Total Assets||7,986,500||250,661,500|
|Asset Turnover Ratio||1.94||0.50|
As you can see, Nordstrom’s ratio is much higher than Verizon’s.
Does that mean that Nordstrom is a better investment than Verizon?
It would require additional analysis and insight into how each company’s ratios are performing over time, and whether they have higher or lower ratios than their direct competitors.
For this reason, it's important to make sure that you're comparing financial ratios to similar companies in order to get an accurate interpretation of the management team and operating results.
Evaluating a company’s asset turnover ratio will give you insight into whether a company is doing a good job of turning assets into profits and cash flows for the business.
Strong companies invest in assets that deliver a high return to the Company and its shareholders. A high return on assets can lead to increased operations and higher growth rates for successful companies.
You are now set with the total asset turnover ratio calculator, as well as the understanding and brainpower you need to calculate and analyze a company’s asset turnover, but don’t stop there!
And if you’re looking to invest in company’s with impressive asset turnover ratios, use our customizable stock screener to find undervalued companies with high asset turnover.