Asset Turnover Ratio Definition, Formula and Example
Asset Turnover ratio definition – A measure of how efficiently a company uses its assets. To calculate, divide sales by assets. In general, the higher the number, the better.
In general word, thus ratio signifies how efficiently the firm uses its assets to generate sales or revenue. For example, the ratio of sales to assets is 0.6 :1. This implies that spending of 1 rupees leads to 6o paise of sales. In simple words, it indicates the sales with respect to spending of Rs 1 of the firm’s assets. Using the fiscal year, this ratio is calculated on yearly basis. In addition to this, it one of the types of ratio analysis.
Formula
Asset Turnover Ratio = Net Sales / Average Total Assets
Net sales are shown in the Income statement of the company. To get the true measure of the sales, refunds are minus from the sales.
Net sales = Gross Sales – Refunds due to defects in items
Average total assets is the addition of beginning and ending total assets balances and then divide them by 2. For this purpose Balance sheet of two consecutive years is taken.
Average Total Asset = (Beginning year total assets balance + total assets balance at the end of year)/2
Asset Turnover Ratio Example
In order to understand asset turnover ratio definition more clearly, let’s discuss an example –
Vardaana tech is a tech company that is manufacturing the laptops for the first time. They want investors in order to start this new project. In this respect, they are meeting a venture capitalist. This venture capitalist want to know the efficiency of the assets of Vardaana. For this purpose he asks for the financial statement.
Financial statement consists of the following items –
| Balance of assets in the beginning of the year | 5,00,000 |
| Assets balance at the end of the year | 7,00,000 |
| Gross Sales | 4,00,000 |
| Refunds due to defect in items | 50,000 |
So, Total Asset Turnover Ratio = [(4,00,000-50,000)/(5,00,000 + 7,00,000)]/2
= 0.14
This implies that the firm only generates 14 paise of sales by spending Rs. 1
Interpretation
This is one of the types of turnover ratio. Higher assets turnover ratio is always good for the organisation. This indicates that the firm is using its assets very effectively and efficiently. The lower ratio indicates the company is unable in utilizing its assets to their full potential. This could be because of insufficient management or due to problems in production.
Ratio equals to 1 indicates that net sales of a company is equal to average total assets for the year. This simply indicates that the firm is generating 1 Rs of sales for every rupee invested in the assets.
However, this ratio may differ from industry to industry. So to get a true picture, it should be compare with firm’s within the industry.
