The asset turnover ratio measures a company's efficiency and productivity. Calculated by dividing a company's sales by its total assets, it indicates the amount of revenues, or sales, a company generates for each dollar of assets. It is the higher the asset turnover ratio, the more efficient a company. Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to generate sales.
For example, assume company ABC and company DEF are both big-box retailers. Last year, company ABC earned $500,000 in sales and had total assets of $3 million. Company ABC's resulting asset turnover ratio is 0.17. Therefore, for every $1 worth of assets, the company only earns 17 cents in revenues.
On the other hand, company DEF earned $500,000 in sales and had total assets of $200,000. Company DEF's resulting asset turnover ratio is 2.50. Therefore, for every $1 worth of assets, the company earns $2.50 in revenues.
Company ABC can increase its asset turnover ratio by not letting its merchandise build up in storage. Rather, company ABC should always keep its shelves fully stocked with salable items at all times. It should also limit purchases of inventory until it needs additional supplies. Company ABC could increase its asset turnover ratio by only purchasing new inventory after most of its items are bought.
Company ABC may also look to increase its sales by staying open 24 hours a day to efficiently use its assets around the clock. Therefore, the company has the potential to generate more sales. The company could also look to reduce its assets by closing some of its stores that have not been efficiently generating sales or that have been operating at a loss.