Assessing Asset Turnover
Asset turnover measures the efficiency of an organization's assets (such as plant and equipment), by calculating the sales generated in relation to the value of assets held.
Asset turnover demonstrates whether an organization is making best use of its assets. For example, a business that reduces machinery downtime gets good value from its investment in this particular asset.
On the whole, a higher number is more desirable. It also tends to indicate lower profit margins, and vice-versa.
Asset turnover can also reveal an organization's capital intensity (how much the production process relies on capital input—usually in relation to labor). Some sectors with minimal assets—such as software development—can expect impressive sales for each dollar's worth of assets, while others may need a much larger asset base to achieve good results.
Alongside profit and loss accounts, asset turnover can also prove a useful indicator of an organization's general financial health.
The formula for asset turnover is simply sales divided by assets, expressed as a simple ratio:
Where total assets is an average figure, calculated by adding total assets at the beginning of the year to those at the end of the year, and dividing the result by two.
Suppose annual sales are $1.29 million, and total assets are $550,000 at the beginning of the year and $600,000 at the end. Average assets are therefore $575,000, so the ratio looks like this:
The formula can be adapted for specific kinds of asset—such as sales revenue divided by fixed assets. In this example, average fixed assets are $275,000, so asset turnover would be:
- Asset turnover is particularly useful when growth companies need to analyze how revenue is increasing in relation to assets.
- The ratio can also help compare competitors within different sectors. Like most such calculations, it varies from sector to sector and the results tend to be more meaningful over longer time periods.
- If a ratio is too high, it can be indicative of overtrading (focusing too heavily on sales rather than investment). Likewise, a lower ratio may suggest that sales are being neglected, and that assets are poorly managed.
- A decreasing ratio may suggest overinvestment in particular assets, or failure to make the best use of those that already exist.
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