Definition of 'Asset Turnover'
Asset turnover is a financial ratio (often referred to as asset turnover ratio) comparing the overall total sales to the value of the investment or company’s total assets. Asset turnover is applied on an annual basis, often used to determine the company’s level of performance.
TheStreet Explains ‘Asset Turnover’
The asset turnover ratio is used to help business managers determine how efficiently they are using company assets to generate sales within a calendar year. To calculate, divide the net sales by total assets:
Asset turnover ratio = net sales / average total sales
For instance, Dorene’s Beauty Supply Store is a new full-service hair, nail and skin care supply store looking for new investors. In Dorene’s business plan she includes her asset turnover ratio to show investors she can be profitable and uses assets efficiently.
Dorene opened her doors with $100,000, ended the year with $200,000 and has net sales of $50,000. Using the formula, Dorene’s asset turnover ratio is 3. This means that for every dollar in assets, Dorene is making $3--pretty successful!
When considering net sales, managers should consider ratio returns and refunds to arrive at an accurate figure. Also, average total sales result is when the beginning and end total assets are added and then divided by two.
A higher asset turnover ratio means the company is utilizing company assets efficiently, meaning the company is making the most out of both management and product or service production. A lower asset turnover ratio signals an internal problem that requires attention if the company plans to thrive in the future.
Not all asset turnover ratios are created equal in terms of comparing industries and companies. Large retailers like Target would have a far higher asset turnover than an equally as successful company like AT&T. Both companies are thriving but produce significantly different products/services, which impacts the asset turnover ratio. Comparing the asset turnover ratio between these two companies would be fruitless and would not render any insightful evidence.
Designed in the 1920’s by the DuPont Corporation, asset turnover became part of the company’s investigation into efficiency and profitability. The company examined return on equity (ROE) into three parts: asset turnover, profit margin and financial leverage. Reviewing these three aspects allowed the company to determine the ROE level in order to identify specific contributions to the ROE level and performance.
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