Asset turnover ratio is defined as the ratio between a company’s sales to its assets. It acts as an indicator of a company’s efficiency in deploying available assets to generate revenues. Asset turnover ratio is therefore considered to be an important determinant of a company’s performance.
The higher an asset turnover ratio, the better a company’s performance is considered to be. Asset turnover ratio can differ across companies. It is generally calculated annually for a specific financial year.
The asset turnover ratio is one of the efficiency ratios used while carrying out fundamental analysis of a company. It measures a company’s ability to generate sales using its assets. This ratio compares a company’s net sales to average total assets, thus enabling investors and creditors to determine how efficiently a company is using its assets to generate sales.
The total asset turnover ratio estimates net sales as a percentage of total assets. This shows the number of sales generated from every rupee of company assets.
The asset turnover ratio is calculated as –
Net sales / Average total assets
The final value must be divided by two to get average total assets.
XYZ Tech Co. is a technology start-up in the business of manufacturing new tablet computers. The company is currently on the lookout for new investors. During a meeting with the company, the investors want to know how well it can use its assets to produce sales.
Upon requesting for the company’s financial statements, here is what was found:
Beginning assets: Rs 40,00,000
Ending assets: Rs 10,00,000
Net Sales: Rs 25,00,000
The asset turnover ratio will therefore be –
= 25,00,000/(40,00,000+10,00,000)
= 0.5
A ratio of 0.5 means that every rupee of XYZ company’s assets are able to generate Re. 0.5 of sales.
A higher asset turnover ratio is always favourable since
Lower ratios are an indication that the company is unable to make the best use of its available resources and may likely have internal issues.
It is important to note that a company’s asset turnover ratio can be impacted by:
The asset turnover ratio is very important for investors in comparing companies within the same sector or group. Comparing a retail company’s asset turnover ratio to that of a telecom firm may not be of use, since this ratio could vary across business segments. To make meaningful comparisons, investors must compare asset turnover ratios of different companies within the same sector.
Here are some of the key benefits of using an asset turnover ratio while evaluating a company:
Some of the aspects to be noted while using asset turnover ratio are:
Asset Turnover ratio is an important measure to analyse the capability of a company in utilizing its assets for generating revenues. It helps investors go beyond a good business plan and good earnings of a company to carefully analyse it’s inner ability. ATR can be a good tool for long-term investors, especially those who are looking to fetch larger value from their investment.
Efficiency ratios measure a company’s capabilities in using its resources for maximizing earnings. These are often used by investors as part of fundamental analysis.
Efficiency ratios are used by investors while evaluating companies for potential investments, as it can help them in making the right choice. Using this, investors can select companies that have a strong financial health and reflect higher potential for growth.
Some of the commonly used efficiency ratios include inventory turnover ratio, asset turnover ratio, accounts payable ratio, and accounts receivable ratio.
Ratio analysis is mostly based on past or historical information and is therefore not reflective of the current state. It may not consider external factors such as economic uncertainties, and also eliminates consideration of human elements within a company.
Ratio analysis is a management tool that aims to improve the understanding around financial results of a company and its trends. It offers key highlights of organizational performance. It can be used to identify strengths and weaknesses to further form strategies and initiatives.
This Diwali, we present a portfolio that reflect both sector-specific and stock-specific opportunities. With 2…
Thank you for showing interest in taking a BTST position using our Delivery Plus product.…
Thank you for showing interest in the consultation on trading strategies! Our expert will reach…
Even if you are a new participant in the stock market, the process of buying…
A company’s debt position can be gauged using the interest coverage ratio or ICR. This…
Muhurat Trading, a cherished tradition in the Indian stock market, takes place on Diwali, the…