Asset Turnover Ratio

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What is 'Asset Turnover Ratio'

Asset turnover ratio measures the value of a company’s sales or revenues generated relative to the value of its assets. The Asset Turnover ratio can often be used as an indicator of the efficiency with which a company is deploying its assets in generating revenue.

Asset Turnover = Sales / Average Total Assets

BREAKING DOWN 'Asset Turnover Ratio'

Asset turnover ratio is typically calculated over an annual basis using either the fiscal or calendar year. The total assets number used in the denominator can be calculated by taking the average of assets held by a company at the beginning of the year and at the year’s end.

Generally speaking, the higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets. The asset turnover ratio tends to be higher for companies in certain sectors than in others. Retail and consumer staples, for example, have relatively small asset bases but have high sales volume and, thus, often yield the highest asset turnover ratio. Conversely, firms in sectors, such as utilities and telecommunications, which have large asset bases will have lower asset turnover. Since this ratio can vary widely from one industry to the next, considering the asset turnover ratios of a retail company and a telecommunications company will not make for an accurate comparison. Comparisons are only meaningful when they are made for different companies within the same sector.

Practical Example of the Asset Turnover Ratio

Let's calculate the asset turnover ratio for four companies in the retail and telecommunications sector - Wal-Mart Stores Inc., Target Corporation, AT&T Inc., and Verizon Communications - for the fiscal year ended 2016.

(in millions) Wal-Mart Stores Target Corp. AT&T Inc. Verizon Communications
Beginning Assets $199,581 $40,262 $402,672 $244,175
Ending Assets $198,825 $37,431 $403,821 $244,180
Average Total Assets $199,203 $38,846.50 $403,246.50 $244,177.50
Revenue $458,873 $69,495 $163,786 $125,980
Asset Turnover Ratio 2.30 1.79 0.41 0.52

 

For every dollar in assets, Wal-Mart generated $2.30 in sales, while Target generated $1.79. Target's turnover may indicate that the retail company is experiencing sluggish sales or holding obsolete inventory. Furthermore, its low turnover may also mean that the company has lax collection methods. The firm's collection period may be too long, leading to a higher accounts receivable. Target could also not be using its assets efficiently - for example, fixed assets such as property or equipment could be sitting idle or not being utilized to their full capacity.

AT&T and Verizon have asset turnover ratios of less than 1, which is typical for firms in the telecommunications sector. Since these companies have large asset bases, it is expected that they would slowly turnover their assets through sales. From the table, it is clear that Verizon turns over its assets at a faster rate than AT&T. Clearly, it would not make much sense to compare the asset turnover ratios for Wal-Mart and AT&T, since they operate in very different industries. But comparing the asset turnover ratios for AT&T and Verizon Communications Inc. (VZ), for instance, may provide a clearer picture of asset use efficiency for these telecom companies.

Limitations of the Asset Turnover Ratio

While the asset turnover ratio should be used to compare apples to apples and oranges to oranges, this kind of comparison does not necessarily paint the clearest possible picture. It is possible that a company’s asset turnover ratio in any single year differs substantially from previous or subsequent years. For any specific company, then, one would do well to review the trend in the asset turnover ratio over a period of time to check whether asset usage is improving or deteriorating.

The asset turnover ratio may be artificially deflated when a company makes large asset purchases in anticipation of a higher growth. Likewise, selling off assets to prepare for declining growth will artificially inflate the ratio.

Many other factors can affect a company’s asset turnover ratio in a given year, such as whether or not an industry is cyclical.

Using the Asset Turnover Ratio and Related Ratios

The Asset Turnover ratio is a key component of DuPont analysis, a system that the DuPont Corporation began using during the 1920s. To understand how companies can increase return for their shareholders, the DuPont analysis breaks down Return on Equity (ROE) into three parts, one of which is asset turnover, the other two being profit margin and financial leverage.

DuPont analysis: ROE = Profit Margin x Asset Turnover x Financial Leverage

Sometimes, investors and analysts are more interested in measuring how quickly a company turns its fixed assets or current assets into sales. In these cases, the analyst can use specific ratios, such as the fixed asset turnover ratio or the working capital ratio to calculate the efficiency of these asset classes.