Understanding and Using the Total Asset Turnover Ratio
Turnover ratios are useful tools when analyzing your business’ performance. These ratios allow you to view and compare past years’ ratios with more recent years' ratios. This comparison can help you determine where you might need to make adjustments. You can also use it to compare against industry averages to see how your business measures up.
The total asset turnover ratio is a ratio that compares your net sales to your total assets. It is a measurement of how well your assets are contributing to your sales and is usually determined during a financial analysis.
A high total asset turnover ratio tells you that your assets are working very well for you, whereas a lower ratio shows the opposite. A high ratio is generally considered better, but it's dependent on your business and industry.
Elements of the Formula
Net sales are listed on your income statement and are your total revenues less your returns, allowances, and any discounts you may have provided.
Net Sales = Total Revenues - Returns - Allowances - Discounts
Total assets are the value of all of your assets, found on your balance statement. Your total assets can include cash, accounts receivable, fixed assets, and current assets.
Current assets are assets you expect will be converted to cash within a year's time. These assets could include accounts receivable, inventory, or any other type of asset that is liquid—in this context, liquid refers to the ability to turn the asset into cash.
Fixed assets do not get converted into cash. Buildings and equipment that your business keeps and uses are examples of fixed assets. If you sell used equipment, then the equipment you sell would be a current asset, whereas the equipment you keep for running your business is a fixed asset.
Accounts Receivable are the accounts you have allowed customers to use credit to purchase on. Expected revenues are an asset.
Total Assets = Cash + Accounts Receivable + Fixed Assets + Current Assets
The formula for the ratio is:
Total Asset Turnover = Net sales ÷ Total assets
Interpreting the Ratio
Ratios become useful only when you can compare them against the same ratio for your company from previous periods, or to a similar company in the same business sector. You can use the industry ratio for comparison as well, although this will be less accurate due to the myriad ways similar businesses in an industry can operate.
When comparing the total asset turnover ratios from two different companies, the companies need to be similar in cost structure, or goods and services produced. The company being compared should also be a match in revenue size, value of assets, and geographic location.
For example, if your business uses local suppliers, with your trucks running the supplies, and a local competitor uses suppliers from out of state with the supplier's trucks, an asset turnover ratio comparison might not be useful. It would be more useful in this situation for comparing your business' performance over periods of time.