How to Use The Asset Turnover Formula (Plus Examples)
By Indeed Editorial Team
Published 29 September 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The asset turnover formula is a calculation that can determine how efficiently a company is using its assets to generate revenue. The formula is important for investors and analysts to understand as it can give insights into a company's financial health and overall profitability. Knowing how to use it can help you make more informed investment decisions and better understand a company's financial situation. In this article, we explain what the asset turnover ratio is, define what the formula means, explain how to use it, discuss its importance and provide you with examples.
What is an asset turnover ratio?
To find the asset turnover formula, it's important to first understand what the asset turnover ratio is. The asset turnover ratio is a financial ratio that measures how efficiently a company uses its assets to generate revenue. You can use this ratio to evaluate a company's overall financial health and performance. Assets are anything that a company owns and can use to generate revenue, such as cash, inventory, property and equipment.
Turnover is a measure of how frequently a company uses its assets to generate revenue. A higher turnover ratio is usually better because it indicates that a company is using its assets more efficiently to generate revenue while a lower turnover ratio indicates that a company isn't using its assets as efficiently as possible. For example, if the asset turnover ratio is 1, it means that for every dollar of assets, the company generates one dollar of revenue.
Asset turnover formula
The formula is a mathematical equation that can calculate the asset turnover ratio. Total sales is the total revenue generated by a company in a given period of time. The average total assets is the average value of all assets the company owns during the same period of time. The formula is:
Asset turnover ratio = total sales / average total assets
To use the formula, you use the total sales and average total assets which you can find on a company's balance sheet. This formula typically applies to one single fiscal year, meaning you look at how much money in total the company generated in one year through their sales and divide it by how much their assets were worth on average throughout that same year. You find this average by adding up the beginning and ending asset values and dividing it by two.
How to use the asset turnover formula
This is a step-by-step guide on how to calculate the formula:
1. Identify the beginning value of the company's assets
The first step is to identify the value of all assets the company owns at the beginning of its fiscal year. You can usually find this number on the company's balance sheet. Remember that the fiscal year doesn't always start in January.
2. Find the end value of the company's assets
Next, identify the value of the company's assets at the end of its fiscal year. This is exactly 12 months after the date from the first step. For example, if the beginning date is the first of January, then the end date is the first of January the following year.
3. Add the values together
After you find the beginning and end values, you can add them together. This gives you the total value of assets for the entire fiscal year. For example, if the beginning value is $1,000 and the end value is $1,500, then the total value is:
$1,000 + $1,500 = $2,500
4. Divide by two to find the average value of assets
Now that you have the total value of assets, you can find the average value. To do this, divide the total value by two. This gives you the average value of assets for the entire fiscal year. For example:
$2,500 / 2 = $1,250
This means that the average value of assets for the year was $1,250.
5. Find the total sales for the company
The next step is to find the total sales for the company in their fiscal year, namely the total revenue generated. You can find this number on the company's income statement. It's important to note that total sales are different from net income. Net income is the profit a company makes after deducting expenses, while total sales is the revenue generated before deducting expenses.
6. Divide total sales by the average value of assets
Once you have both the total sales and the average value of assets, you can apply the asset turnover formula. To do this, divide total sales by the average value of assets. This gives you the asset turnover ratio expressed as a number. For example, if total sales are $5,000 and the average value of assets is $1,250, then the asset turnover ratio is:
$5,000 / $1,250 = 4
This means that the company's assets turned over four times in their fiscal year. This is a high asset turnover ratio, which is good because it means the company is efficiently using their assets to generate sales. In this example, the company's assets generated $4 in sales for every $1 worth of assets. It's important to remember that an asset turnover ratio is a number and not a percentage. You may sometimes see it expressed as a percentage, but this is simply the number multiplied by 100. For example, a ratio of 4 would be 400%.
Importance of the formula for asset turnover
This formula is important for a number of reasons, including:
Shows how efficiently a company is using their assets
The asset turnover ratio measures how efficiently a company is using their assets to generate sales. A high ratio means the company is using their assets efficiently while a low ratio means it could be doing better.
For example, if two companies have the same level of sales but one has a higher asset turnover ratio, it means the first company is using its assets more efficiently to generate sales. This is important knowledge because it can help shareholders make better investment decisions and help the company improve their overall financial health by making changes to increase their ratio.
Helps you compare companies in different industries
You can use the asset turnover ratio to compare companies in different industries because it's a standardised metric, meaning it's not affected by the size or type of company. This is helpful because it allows for an accurate comparison.
For example, you can compare the asset turnover ratio of two retail companies or two manufacturing companies. This is helpful because it allows you to see which company is using their assets more efficiently, regardless of the industry they're in.
Helps you compare a company over time
You can also use the asset turnover ratio to track a company's progress over time. This is helpful because it allows you to see if the company is becoming more or less efficient in their use of assets. For example, if a company's asset turnover ratio increases over time, it means it's becoming more efficient in its use of assets. Meanwhile, if the ratio decreases over time, it means it's becoming less efficient. This efficiency is important because it can have a direct impact on the company's bottom line, meaning its profitability.
It can identify problems early on
The asset turnover ratio is also helpful in that it can help you identify problems early on. For example, if a company's asset turnover ratio starts to decrease, it may be a warning sign that the company is having difficulty generating sales.
This is important information because it can help shareholders make decisions about their investment and it can help the company take corrective action to improve its financial health, such as by increasing its sales or by reducing its assets through downsizing.
Example formulas for asset turnovers
These are some examples of how you can use the formula:
Review this example to learn how to apply the formula:
Omega Tech Corporation is a company that manufactures and sells a variety of electronic products. The company started the year with $1 million worth of assets and ended the year with $800,000 worth of assets. Throughout the fiscal year, Omega Tech generated $2.5 million in total sales. Using the asset turnover formula, the company's accountant calculates Omega Tech's asset turnover ratio as:
Average total assets: $1 million+$800,000 / 2 = $900,000
Total sales: $2.5 million
Formula: $2.5 million / $900,000 = 2.78
The company's asset turnover ratio is 2.78.
Here's another example of calculating the asset turnover ratio:
Mountain Inc. is a company that sells a variety of outdoor gear and equipment. The company started the year with $5 million worth of assets and ended the year with $4 million worth of assets. Throughout the fiscal year, Mountain Inc. generated $12 million in total sales. Using the asset turnover formula, the company's accountant calculates Mountain Inc.'s asset turnover ratio as:
Average total assets: $5 million+$4 million / 2 = $4.5 million
Total sales: $12 million
Formula: $12 million / $4.5 million = 2.67
The company's asset turnover ratio is 2.67.
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