What does it mean if the total turnover asset ratio of the company is lower than the industry average?

The success of your business relies on working capital. But working capital doesn’t just include cash flow, it also includes all the assets that are available to cover operational expenses or business costs. Total asset turnover ratio is a great way to measure your company’s ability to use assets to generate sales. Check out our asset turnover definition and learn how to calculate total asset turnover ratio, right here.

Asset turnover definition

Asset turnover ratio is a type of efficiency ratio that measures the value of your business’s sales revenue relative to the value of your company’s assets. It’s an excellent indicator of the efficiency with which a company can use assets to generate revenue. Typically, total asset turnover ratio is calculated on an annual basis, although if needed it can be calculated over a shorter or longer timeframe.

Asset turnover rate formula

Want to know how to calculate total asset turnover ratio? It’s relatively simple. Here’s the asset turnover rate formula that you can use in your calculations:

Total Asset Turnover = Net Sales / Total Assets

So, how does this all work in practice? Let’s look at an example. Imagine Company A has made $500,000 in net sales and has $2,000,000 in total assets. You can use the asset turnover rate formula to find out how efficiently they’re able to generate revenue from assets:

500,000 / 2,000,000 = 0.25 x 100 = 25%

This means that Company A’s assets generate 25% of net sales, relative to their value. In other words, every $1 in assets generates 25 cents in net sales revenue.

It’s important to remember that the asset turnover rate formula relies on you knowing your figures for total assets and net sales. Just to give you a quick refresher course, here are the formulas you can use to work out these two important pieces of information:

Net Sales = Gross Sales – Returns – Discounts – Allowances

Total Assets = Liabilities + Owner’s Equity

What is a good total asset turnover ratio?

The higher your company’s asset turnover ratio, the more efficient it is at generating revenue from assets. In short, it indicates that the company is productive and generates little waste, while it also demonstrates that your assets are still valuable and don’t need to be replaced. A lower asset turnover ratio indicates that a company is not especially effective at using its assets to generate revenue.

It’s important to note that asset turnover ratio can vary widely between different industries. For example, retail businesses tend to have small asset bases but much higher sales volumes, so they’re likely to have a much higher asset turnover ratio. By the same token, real estate firms or construction businesses have large asset bases, meaning that they end up with a much lower asset turnover.

So, what is a good total asset turnover ratio? As total asset turnover ratio varies so much between companies in different sectors, there’s no universally defined figure for a “good” asset turnover ratio, and it doesn’t make sense to compare figures for businesses in different sectors. In the retail sector, an asset turnover ratio of 2.5 or more could be considered good, while a company in the utilities sector is more likely to aim for an asset turnover ratio that’s between 0.25 and 0.5.

How to improve your asset turnover ratio

If you want to boost your total asset turnover ratio, you should look for ways to boost your net sales. There are plenty of strategies that you could pursue. Minimising returns can be a great way to improve your net sales – start by tackling returns fraud and offering store credit as an alternative to refunds. You could also introduce new products or service lines that don’t require any additional investment in assets, thereby opening new revenue streams to your business.

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The asset turnover ratio is an important financial ratio for understanding how well the company utilizes its assets to generate revenue. It is imperative for every company to analyze and improve the asset turnover ratio (ATR). The article highlights the reasons and ways to analyze and interpret asset turnover ratio as an important part of ratio analysis.

Definition of Asset Turnover Ratio

The asset turnover ratio determines the ability of a company to generate revenue from its assets by comparing the net sales of the company with the total assets. We calculate it by dividing net sales by the average total assets of a company. In other words, it aims to measure sales as a percentage of average assets to determine how much sales the company generates by each rupee of assets.

There can be several variants of this ratio depending on the type of assets considered to calculate the ratio, viz. with fixed assets, there is a fixed asset turnover ratio, and similar for current assets and total assets, capital intensity ratio which is reciprocal of this asset turnover ratio that helps in understanding it another way round.

How to Interpret Asset Turnover Ratio?

The asset turnover ratio shows the comparison between the net sales and the average assets of the company. An asset turnover ratio of 3 means for every 1 USD worth of assets and sales is 3 USD. So, a higher asset turnover ratio is preferable as it reflects more efficient asset utilization. However, as with other ratios, the asset turnover ratio needs to be analyzed while considering the industry standards.

Some industries are designed to use assets in a better way than others. A higher asset turnover ratio implies that the company is more efficient at using its assets. A low asset turnover ratio, on the other hand, reflects the bad management of assets by the company. As a result, it may also indicate production or management problems.

Why is it necessary to Improve Asset Turnover Ratio?

Since the asset turnover ratio measures the efficiency of a company in managing its resources to generate its sales, it is very obvious that higher turnover ratios are preferable for reflecting a better state of affairs at the company. This ratio gives insight to the creditors and investors into the company’s internal management. A low asset turnover ratio will surely signify excess production, bad inventory management, or poor collection practices. Thus, it is very important to improve the asset turnover ratio of a company.

How to Improve Asset Turnover Ratio

If a company analyzes that its asset turnover ratio is declining over time, there are several ways for improving the asset turnover ratio:

Increase in Revenue

The easiest way to improve the asset turnover ratio is to focus on increasing revenue. The assets might utilization be proper, but the sales could be slow, resulting in a low asset turnover ratio. The company needs to increase its sales through more promotions and quick movements of the finished goods.

Obsolete or unused assets should be liquidated quickly. Assets that are not used frequently should be analyzed to see whether there is a sense in retaining those. Basically, the company should sell those assets that do not add to the bottom line regularly.

Leasing

Another efficient way is to lease assets instead of buying them. Any leased equipment is not counted as a fixed asset.

Improve Efficiency

The asset turnover ratio could be low because of the inefficient use of assets. The company should analyze how it uses the assets and ways to improve the productivity of each asset. The output should increase without any significant increase in any other expenses.

Accelerate Accounts Receivables

The Slow collection of accounts receivables will lower the sales in the period, hence reducing the asset turnover ratio. The company should focus on quick collection practices. This can include outsourcing the delinquent accounts to a collection agency, hiring an employee just for collecting pending invoices, and reducing the amount of time given to customers to pay.

Better Inventory Management

The company needs to check its inventory management to figure out the time spent in the movement of the goods throughout the process. If the company’s delivery system is slow, there will be delays in getting the product to the customer and collecting the payment on time. So, the company should invest in technology and automate the order, billing, and inventory systems. This will improve sales and increase the asset turnover ratio.

Conclusion

Companies need to keep track of the asset turnover ratio. This ratio helps the company to measure how productive the business is. And how much revenue investment in the assets generates? A high asset turnover ratio is a sign of better and more efficient management of assets on hand. So, the companies need to analyze and improve their asset turnover ratio at regular intervals.

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1. Asset Turnover Ratio [Source]

Activity RatiosAsset TurnoverEfficiency RatiosRatio AnalysisTurnover Ratios