The asset turnover ratio measures the efficiency of a company's assets to generate revenue or sales. It compares the dollar amount of sales or revenues to its total assets. The asset turnover ratio calculates the net sales as a percentage of its total assets.
Generally, a higher ratio is favored because there is an implication that the company is efficient in generating sales or revenues. A lower ratio illustrates that a company is not using the assets efficiently and has internal problems. Asset turnover ratios vary throughout different sectors, so only the ratios of companies that are in the same sector should be compared.
To calculate the asset turnover ratio, divide net sales or revenue by the average total assets. For example, suppose company ABC had a total revenue of $10 billion at the end of its fiscal year. Its total assets were $3 billion at the beginning of the fiscal year and $5 billion at the end. The average total assets are: $8 billion ($3 billion + $5 billion) ÷ 2 or $4 billion. Its asset turnover ratio for the fiscal year is 2.5; that is, $10 billion ÷ $4 billion.
On the other hand, company XYZ, in the same sector as company ABC, had a total revenue of $8 billion at the end of the same fiscal year. Its total assets were $1 billion at the beginning of the year and $2 billion at the end. The average total assets are $1.5 billion. Therefore, the asset turnover ratio is 5.33: that is, $8 billion ÷ $1.5 billion.
Comparing the two asset turnover ratios, company XYZ is more efficient in using its assets to generate revenue.