What it means
Assets are expensive to buy and run, so owners want to know how hard they are working. Asset turnover answers this by comparing sales over a period with the average value of the assets used to produce them.
If a company sells $2 for every $1 of assets, its turnover is 2.0. The ratio is one of the three building blocks of the DuPont analysis, a framework that explains return on equity.
The other two are profit margin and financial leverage (the use of debt). A business can earn a good return either by making a high margin on each sale or by turning over its assets quickly, and many of the best performers manage a balance of both.
Industries show very different patterns. A supermarket makes a thin margin but turns its assets many times a year, while a utility or a hotel holds heavy assets and turns them slowly.
This means asset turnover should be compared with direct competitors and not with the economy as a whole. The ratio is usually calculated with average assets, being the opening and closing balances divided by two, to reflect that assets change during the year.
Using the closing figure alone can distort the answer if the company has just made a big purchase or sale. A rising asset turnover usually signals better efficiency, but it can also result from old, heavily depreciated assets that are nearly worn out.
A falling figure may point to idle capacity, bloated inventory, slow-paying customers or a recent investment that has not yet generated sales. A practical way to use the ratio is to break the asset base into its parts and ask which one is dragging the figure down.
Dividing sales by average receivables shows how quickly customers pay, dividing cost of sales by average inventory shows how fast stock moves, and dividing sales by fixed assets shows how hard the equipment works. Looking at each piece points directly to the area where management can act.
In practice
Real-world examples
Example 1
A discount grocer with $40,000,000 of average assets reports sales of $160,000,000, giving a turnover of 4.0. Its low margins are acceptable because it turns its assets quickly.
Example 2
A hotel group has $90,000,000 of average assets and revenue of $45,000,000. Its turnover is 0.5, which is normal for a business that owns valuable buildings.
Example 3
A consulting firm sees its turnover fall from 3.0 to 2.2 after it moves into a large new office. The finance director asks whether the extra space is being used enough to justify its cost. The board agrees to review the ratio each quarter until the new offices are fully occupied and the figure recovers.
Think of it
Asset turnover is like measuring how many times a restaurant turns over its tables per night. More turns mean more revenue from the same space.
Formula
Calculation
Asset turnover = Net sales / Average total assets
Average total assets = (Opening total assets + Closing total assets) / 2
Suppose a furniture maker had net sales of $6,000,000 for the year. Its total assets were $2,800,000 at the start of the year and $3,200,000 at the end. Average total assets = (2,800,000 + 3,200,000) / 2 = $3,000,000. Asset turnover = 6,000,000 / 3,000,000 = 2.0. Every $1 of assets generated $2 of sales.Case study
Seen in the real world
Tidewater Bicycles is an illustrative, fictional manufacturer that sold $9,000,000 of bikes in the year on average assets of $6,000,000, giving an asset turnover of 1.5. A competitor of similar size reported 2.1.
The finance manager investigated and found two causes: stock of unsold frames had grown to $1,200,000, and a second assembly line ran only two days a week. She recommended a stricter buying plan and a rota that filled the idle line with a contract order.
A year later sales were $9,900,000 and average assets had fallen to $5,500,000, a turnover of 1.8. The illustrative result shows that turnover can improve through better use of assets as well as higher sales. She presented the breakdown to the board, showing that tighter stock control alone had added roughly 0.2 to the turnover, which was more than the extra sales from the new contract order.
Watch out
Common mistakes
- Comparing the ratio across industries, when a retailer and a power company have naturally different levels.
- Using the closing balance sheet figure instead of the average, which can distort the result after a large purchase or disposal.
- Assuming a higher number is always better, when it can reflect old, heavily depreciated assets that will need expensive replacement.
Questions
People also ask
What is a good asset turnover?
There is no universal figure, so it should be compared with competitors and with the company's own history.
How can a company improve its asset turnover?
By raising sales from the same assets, reducing idle stock and equipment, or collecting from customers faster.
Does asset turnover measure profit?
No, it measures sales efficiency, and it needs to be combined with profit margin to judge returns.
Watch