The total asset turnover ratio is useful to investors. They can anticipate the company’s profitability prior to investment using a total asset turnover ratio.

This is a calculation that helps a company use its assets to generate revenue. If you are interested in corporate finance, then this is an important calculation for you to ask.

Read this article to get a clear and complete idea about the asset turnover ratio. You will learn the formula for total asset turnover ratio calculation and how it works. 

What is Total Asset Turnover?

Total asset turnover or total asset turnover ratio is a parameter showcasing a company’s efficiency in using its resources to generate a desired amount of revenue.

Calculating this ratio involves using the company’s total gross revenue and its asset lists. Financial analyzers compare the total gross revenue and the entire list of assets at the company’s disposal. Furthermore, the process helps reveal the number of sales each dollar of the company assets could generate. 

Usually, the asset turnover ratio is not used internally in a business. In most cases, third parties such as investors have to calculate the total asset turnover ratios or total asset turnover. The purpose here is to understand a business’s use of its assets for profitability. 

This ratio helps investors and third parties understand how a business is using its assets for profitability. Furthermore, they can also examine some of the businesses’ weaknesses.

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How Does Total Asset Turnover Work? 

According to Investopedia, “The asset turnover ratio measures the value of a company’s sales or revenues relative to the value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue. The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets.” 

However, if a company has a low total asset turnover ratio, it shows that the company is unable to use its assets to generate more sales. You can find out the total asset turnover by dividing the total sales or revenue of the company by the average assets of the company.  

Basically, with the help of this metric, you can understand how a particular company is using its assets to generate more sales for itself. At the time of investing, an investor assesses a company’s total asset turnover. Here, a particular investor can compare the ratios of different companies that act similarly. 

However, large asset sales can also affect the total asset turnover ratio of a particular company. Furthermore, significant purchases of assets can also impact a company’s ratio in this case. 

Generally, companies calculate the asset turnover ratio every year. If a company has a higher total asset turnover ratio, that means the company is performing better. This also shows that the company is able to generate more revenue with every asset dollar it has.

How To Calculate The Asset Turnover?

It is pretty simple. In most cases, small and larger-sized businesses use the balance sheets from the year’s start and the year’s end. Next, It requires dividing the annual gross income by the average total assets of a company. 

If you break it down into a formula, then it will look something like this –

There is another formula that helps you calculate the total asset turnover ratio. For that, you have to add the beginning assets to the ending assets and divide the result by 2. Here is what it looks like if you make a formula out of this –

When you follow the second formula, you must know what the term means. The beginning asset means the total assets at the start of the year. The rest of the ending asset signifies the assets at the end of the fiscal year. 

Hence, you can see the value of the company’s assets in the denominator. To find out the number of assets of a company, you will first need to find the average value of the company’s assets. 

What Does the Total Asset Turnover Ratio Work? 

As discussed before, a company shows a high-performance graph when its total asset turnover ratio suggests that it can generate more revenue per dollar of assets. A low result of the total asset turnover ratio means that the company is not performing at the peak of its efficiency. 

Also, the company is not using its resources efficiently to make the most out of them. A low asset turnover ratio can also suggest that the company is going through internal conflicts. 

This measurement parameter is usually checked and followed by investors and creditors. 

They use it as a resourceful analysis of the company’s profitability. Companies with a high total asset turnover ratio show that they are capable of operating with fewer assets than their competitors, who are less efficient. This is a sign of lower investment risks and a chance of higher.

It is important to check the company’s trends over time to analyze the asset turnover ratio. One can do it by plotting all the data points on a trend line. Besides, it will help observe patterns of increase and decrease.

But, the profitability of a company will only be visible when this ratio is compared to that of the competitors. Furthermore, this ratio cannot be the same in all business sectors. For example, the retail sector has higher sales volumes compared to the lower asset bases. This creates a high asset turnover ratio. 

Contradictorily, business sectors like real estate and utilities can often have large asset bases compared to their lower sales volume. In addition,these sectors usually generate much lower total asset turnover compared to others. 

Different Types of Asset Turnover Ratios

During financial analysis, investors follow different variations of this ratio. It helps gain insights into different aspects of the company. Furthermore, the most common variations of the ratio provide insights into different aspects of how a company runs its operations. 

There are two common variations of the asset turnover ratio. Fixed and Total asset turnover ratios –

Fixed Asset Turnover Ratios

The fixed asset turnover ratio measures a company’s capability to generate revenue in relation to its investment in fixed assets. Fixed assets refer to assets used and acquired for the long term. 

These assets have a practical life of more than a year. Company equipment and machinery are included in this type of property. Property plants and equipment are among the types of property included in this type of property. More so, his ratio evaluates the efficiency of a company in dealing with its fixed assets for generating sales. 

Here is the formula for the same –

As explained before, a higher turnover ratio for the fixed assets suggests the company’s efficiency in generating maximum revenue using the fixed assets. It suggests future prospects for growth. A low turnover ratio, on the other hand, means lower efficiency. 

Total

The total asset turnover ratio is the parameter for evaluating a company’s ability to generate revenue using both the current and fixed assets. Total asset turnover requires the use of all the company’s investments. This Parameter requires the use of all the investments of the company. Investors get insights about the broader aspects of the company’s operations through this parameter.

Here is the formula –

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Some Essential Details of Asset Turnover Ratio 

Once you start researching the asset turnover ratio, you will find out that this ratio is higher for companies in certain sectors than others. For example, in the retail industry, where they sell staple items, there is a high asset turnover ratio despite having small assets. This is because they have a high sales volume.  

On the other hand, various companies in the utilities sector and real estate have a low asset turnover ratio despite having a large base of assets. 

Hence, you can see that this ratio varies a lot from one industry to the next. Therefore, it is not always possible to compare the asset turnover ratio among companies of different industries. As a result, you must understand that you can only make a meaningful comparison, when you compare the asset turnover ratio of different companies within the same sector. 

Bottom Line

A company with a higher asset ratio suggests it uses its fixed assets efficiently. However, when calculating any ratio, remember to always follow the industry benchmark for a clear and meaningful interpretation. Hopefully, this article helped you understand all about total asset turnover.

Will you be able to calculate a company’s asset turnover ratio after reading this article? Let us know if you have any feedback to share.

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