What is the Asset Turnover Ratio?

Calculating turnover rates involves seeing how many assets are necessary to produce a company’s revenue. When we divide monthly net sales by the average amount of assets, we get the asset turnover ratio. A greater ratio says the business is making the most of its resources to achieve sales, but a lower rate may suggest the opposite.

This allows investors and creditors to assess a company’s results. In comparing the ATR of several companies in a sector, they discover which business is making the best use of its assets while also achieving favourable outcomes.

Read on to know more.

Understanding the Asset Turnover Ratio Formula 

The ratio is obtained by dividing net sales by the average total assets. How effectively a business makes its assets turn into profits is measured by this ratio. A higher ratio typically indicates better asset utilisation.

The asset turnover ratio formula is:

Asset Turnover Ratio = Net Sales / Average Total Assets 

Where:

• Net Sales is the revenue after deducting sales returns, discounts, and allowances. 

• The balance sheets for both the start and end of a financial year are used to calculate average total assets. The following is the formula to calculate the average total assets.

Average Total Assets = (Beginning Assets + Ending Assets)/ 2

The balance sheet on the first day of the financial year already resembles the real situation. Total assets available at the end of the financial year are referred to as the ending assets.

Asset Turnover Ratio Meaning and Its Significance

The asset turnover ratio’s meaning resides in its use for evaluating the efficiency of the company in the process of using the assets to bring in sales. A high ratio means that the company is performing better since it indicates higher revenue collected from units of assets.  On the other hand, a smaller ratio might mean unused assets or inefficiencies in operations. 

This ratio is especially appropriate for companies from the same industry because asset utilisation may differ a lot from industry to industry.  

Total Asset Turnover Ratio Example

Consider a company with:

• Net Sales: ₹50 lakh
• Beginning Total Assets: ₹40 lakh
• Ending Total Assets: ₹60 lakh
• Average Total Assets = (₹40 lakh + ₹60 lakh) / 2 = ₹50 lakh
• Asset Turnover Ratio = ₹50 lakh / ₹50 lakh = 1.0

This means the company generates ₹1 in sales for every ₹1 invested in assets, indicating efficient asset utilisation. 

Fixed Asset Turnover Ratio Meaning

The fixed asset turnover ratio is a measure that only pays attention to the manner in which companies utilise fixed assets in generating sales. It is calculated by the net sales divided by the net fixed assets.This ratio is especially important for capital-intensive industries where high levels of fixed assets investments are the norm.  

Fixed Asset Turnover Ratio Example

Its purpose is to show whether the company is efficiently converting its fixed assets into sales. A higher ratio signifies a company uses its assets efficiently, but a lower one suggests the company may not use its resources well. I’ll show you how it works through this clear example.

Suppose a manufacturing firm has:

Net Sales: ₹80 lakh

Net Fixed Assets: ₹20 lakh

Fixed Asset Turnover Ratio = ₹80 lakh / ₹20 lakh = 4.0

Every rupee invested by the company in fixed assets brings returns of ₹4 in sales, showing that it is efficient at making revenue with these assets..

Factors Influencing Asset Turnover Ratios

The asset turnover ratio for a company can be changed by a number of influences.

• Industry Type: Firms that put most of their resources into property, machines, and equipment may display lower profitability ratios.
• Business Model: Working in a service-based business usually gives a company an asset-light structure and higher ratios.
• Operational Efficiency: Effective management of inventory, assets, and receivables increases the turnover ratios.

Also Read: Working Capital Turnover Ratio

Limitations of Asset Turnover Ratios

Even though asset turnover ratios are useful, there are some restrictions to their use:

• Industry Variations: When comparing different industries, it often doesn’t make sense because each industry requires a different type of asset.
• Accounting Practices: Because accounting methods may differ, the value of a company’s assets and thus the ratio can be influenced.
• Temporal Changes: The asset turnover ratio might vary throughout the year because of changes in sales and assets, so it should be closely watched.

Divide the net sales by a firm’s average total assets to find out the asset turnover ratio. It helps you notice how well the business uses its assets to generate revenue. It lets you compare how companies are doing compared to others. It also allows management to notice where staff performance can be better and where stock management can improve.

FAQs on Asset Turnover Ratio

What are good asset turnover ratios?

The rate at which a company uses its assets changes from one industry to another. Normally, a big difference between assets and sales means a company is making good use of its resources. A retail company may achieve a debt ratio greater than 2.0, while the ratio for a utility firm usually falls below 1.0.

Is 0.8 a good asset turnover ratio?

In other words, ₹0.80 of sales are made for every ₹1 in assets held by the company. Whether you’re paid well here depends on the industry standard. In industries known for high asset turnover, 0.8 may mean the company is not making full use of its assets. 

Is 1.5 a good asset turnover ratio?

When a company achieves a ratio of 1.5, it means for every ₹1 in assets it has, it generates ₹1.50 in sales, which is usually seen as being good. It proves that revenue is being efficiently created from assets, especially when the results either reach or outperform those seen in similar industries.