Asset turnover ratio determines the ability of a company to generate revenue from its assets. It is calculated by dividing net sales by average total assets of a company. In other words, it aims to measure sales generated per unit of assets.
Asset Turnover Ratio = Net Sales / Average Total Assets
Total Assets = Fixed Assets + Current Assets or Asset side total of the Balance Sheet
A higher asset turnover ratio is preferred as it reflects more efficient asset utilization. However, as with other ratios, the asset turnover ratio needs to be analyzed while keeping in mind the industry standards. Some industries are designed to use assets in a better way than others e.g. auto maker like Maruti may have a better turnover than Symphony making air coolers, which are seasonal in nature. A higher asset turnover ratio implies that the company is more efficient at using its assets. A low asset turnover ratio, on the other hand, reflects the bad management of assets by the company and may also indicate production or management problems.
Let’s compare the asset turnover ratios of two cement companies for FY 2018 - Ultratech Cement and JK Cement. Since they are in the same industry, the comparison will be apt and justifiable.
Average Total Assets
Rs. 49,688 crore
Rs. 6,432 crore
Rs. 32,305 crore
Rs. 5,020 crore
Asset Turnover Ratio
In the above case, since JK Cement has a better asset turnover ratio in comparison to Ultratech, it is implied that JK Cement has made a more efficient and effective use of its assets to generate revenue i.e. for each unit of asset deployed, it is able to garner higher revenue as against Ultratech.
Asset Turnover ratio helps the company to measure how productive the business is and how much revenue is generated from its investments in the assets. A high asset turnover ratio is a sign of better and efficient management of assets on hand. So, the companies need to analyze and improve their asset turnover ratio at regular intervals.
Ways to improve Asset Turnover Ratio:
- Increase Revenue
- Liquidate Assets
- Improve efficiency
- Accelerate Accounts Receivables
- Better Inventory Management