This is an ultimate guide on how to calculate Total Asset Turnover ratio with detailed interpretation, example, and analysis. You will learn how to use its formula to assess an organization's efficiency.
Definition - What is Total Asset Turnover Ratio?
The total asset turnover ratio is one of the many efficiency ratios that let you evaluate how well a company is using its assets to generate income.
To accomplish this, the ratio directly measures a firm’s net sales against its average assets, to determine exactly what percentage of those sales is being produced from each dollar of a company’s resources.
An asset turnover ratio of 40%, for example, means that 40 cents out of every asset dollar is being converted into business revenue.
The higher the ratio is, the more efficiently a company is generating sales from its asset base.
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Formula
To calculate the asset turnover ratio for a company you may wish to invest in, you would use the following formula:
Total Assets Turnover Ratio = Net Annual Sales / Average Total Assets
This formula provides a more accurate result by including only the net amount of an organization’s annual sales, after all refunds and returns have been removed from the total sales figure.
For this simple version of the total assets turnover ratio, you can calculate a firm’s average total assets by dividing the combined opening and closing assets of any reporting year by 2.
There are more refined versions of this ratio that will allow you to measure a company’s sales against only its fixed assets, or the amount of its working capital.
Read also: Inventory Turnover Ratio - Formula, Example & Analysis
Total Asset Turnover Calculator
Example
Now let's have a look at a quick example so you can understand clearly how the asset turnover measures.
If you wanted to investigate Company BB as a potential stock investment, you could use the assets turnover ratio to get a better sense of how well the company is using its assets to create sales.
When you examine Company BB’s financial statements for the past year, you discover the following information:
- Net Annual Sales = $5,000,000
- Total Assets at Start of Year = $8,000,000
- Total Assets at Year-End = $12,000,000
By using these figures and the provided formula, you can now calculate Company BB’s total asset turnover, as follows:
So how to get average total assets? You can use the following formula:
Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2)
Interpretation & Analysis
Okay now let's find out how the total asset turnover is used to evaluate a company's efficiency.
A ratio of 1, or 100%, means that a firm is generating a dollar in sales for every dollar in assets that it owns.
So what is a good asset turnover ratio?
Generally speaking, a higher ratio is a more desirable outcome for most businesses.
When the ratio result is relatively high, it tells you that a company is using its resources in the most efficient manner possible to produce income.
When the ratio value is very low, on the other hand, it tells you that a business has a lot of money invested in assets, but isn’t seeing a huge return on those assets in terms of revenue.
In the case of a lower value, you can probably assume that the business you’re analyzing isn’t being managed very effectively, or that it’s experiencing manufacturing or production difficulties that are impacting sales.
As with many other efficiency ratios, it’s important to remember that there are varying industry standards for the asset turnover value.
For this reason, you should always make a point of comparing your results with other companies in the same industry.
Cautions & Further Explaination
Unfortunately, the information provided by the total asset turnover ratio isn’t always of equal value for every potential investment you may wish to explore.
When a specific type of business typically operates without the need for a large asset base, this particular ratio won’t be of much use because it will be unable to make any kind of worthwhile comparison between income and resources.
This is often the case for many service industries, including insurance companies, energy suppliers, and information technology firms.
In general, this ratio is best used to assess and compare asset-heavy businesses, such as car manufacturers or airlines.
