Asset turnover ratio (ATR) measures the company’s ability to generate sales or turnover relative to the value of assets. It is used as a financial indicator by analysts to take an investing decision.
Higher asset turnover ratio indicates that the management is more efficient in generating revenue from its assets. In contrast, a low ATR indicates inefficiency of the management to generate sales.
A ratio of 2 indicates that the company is generating Rs 2 of revenues for every Rs 1 of average assets.
Higher total asset turnover ratio indicates greater efficiency. Low ATR signals inefficiency.
Here is the formula to calculate ATR;
Asset turnover ratio = Total revenue / average assets
Average assets = (assets at the beginning of the year + assets at the end of the year) /2
Here are the steps to be followed to calculate asset turnover ratio;
- Locate assets at the beginning of the year from the company’s last year balance sheet. Value of assets as shown in last year’s balance will be this year’s opening or beginning value.
- Locate assets from the current year’s balance sheet. It is considered as assets at the end of the year.
- Add assets at the beginning of the year and closing of the year. Divide the sum by 2 to get the average value of assets for the year.
- Locate total revenue or sales from the company’s income statement.
- Divide total sales or revenue by the average value of the assets for the year.
What asset turnover ratio indicates
Higher asset turnover ratio indicates better performance of a company. It indicates that the company generates more revenue per one money unit of sales.
Asset turnover ratio varies from industry to industry. For instance retail and consumer sector companies must have small assets but high sales volume, therefore they must have high ATR. Utility and infra sector will have low asset turnover as they generally have a huge asset base with low revenue or sales.
Comparing asset turnover ratio of companies from two different industries will not give you any result. Comparison will be meaningful if it’s between two companies from the same industry.
Example: How to calculate asset turnover ratio
Let us calculate the asset turnover ratio of two companies from the same industry to understand how it is calculated.
| Particulars (INR in Crore) | XYZ Limited | ABC Limited |
|---|---|---|
| Beginning Assets | 21,000 | 42,000 |
| Ending Assets | 23,000 | 51,000 |
| Avg. Total Assets | 22,000 | 46,500 |
| Revenue | 52,400 | 94,000 |
| Asset Turnover | 2.38X | 2.02X |
For every rupee in assets, company XYZ limited generates Rs 2.38 in sales, while company ABC Limited generates Rs 2.02.
Comparing ATR of both XYZ and ABC Limited, it shows that company XYZ limited manages its assets better in comparison to ABC limited to generate revenue.
Asset turnover is part of the famous DuPont analysis.Return on equity breaks down into three components, one of which is asset turnover.
If you are interested to know how efficiently the company has utilized its fixed assets to generate revenue or sales, then use fixed asset turnover ratio.
Fixed asset turnover ratio measures how efficiently the company generates revenues from its investments in fixed assets.
High fixed asset turnover ratio indicates the company is more efficiently using its fixed assets in generating revenue. A low ATR indicates inefficiency.
