This article is for educational purposes and does not constitute financial, legal, or tax advice. For specific advice applicable to your business, please contact a professional.
Asset turnover is a key metric used to describe your company’s financial health. Your asset turnover ratio measures how effectively your company is using the fixed assets and liquid assets that it has to generate revenue. Outside investors will use this ratio to compare your company’s performance to others in the same sector.
As a rule of thumb, the higher your asset turnover ratio, the more financially efficient your business.
Asset turnover is calculated as follows:
- start with the total asset value at the start of the year (beginning assets)
- find the total asset value for the end of the year (ending assets)
- add the total asset value at the start and end of year together and divide by two to get the value for the year’s average assets
- calculate total sales or revenue for the year
- divide total sales by the average value of your assets for the year
Example of asset turnover
Now we know the definition of asset turnover, let’s take a look at an illustrative example.
Let’s say you run a boutique clothing store. This year you made $270,000 in total revenue – slightly higher than the average US small business. Your total assets were worth $20,000 at the start of the year and $30,000 at the end. This gives us $50,000 that we divide by two to get the year’s average. Now, we divide $270,000 by $25,000 for a total asset turnover ratio of 10.8.
Using the DuPont analysis for an asset turnover ratio formula
In the 1920s, the DuPont corporation developed a formula for breaking down its Return on Equity (ROE) across different divisions. The asset turnover ratio is a key component of this. However, it also factors in financial leverage and profit margins. As such, it can provide a clearer picture of how hard your assets are working for you than asset turnover alone.
This is worked out by multiplying asset turnover by profit margin and financial leverage. To calculate profit margin, net income is divided by revenue. Financial leverage is calculated by dividing average assets by average equity.
Frequently Asked Questions about asset turnover
What is fixed asset turnover?
Asset turnover is usually calculated using a company’s total assets. These include both fixed assets like property, machinery and plant, as well as current assets like inventory or cash, and liquid assets like accounts receivable, stocks and other marketable securities. Fixed asset turnover uses the same formula, but only takes fixed assets into account.
What should my company’s asset ratio be?
That depends entirely on your industry. Some sectors are more capital intensive than others. The retail and service industries, for instance, tend to have relatively small asset bases but high sales volumes. Thus, they are likely to have higher asset turnover ratios than sectors like utilities or telecoms.
It’s important to have realistic expectations of your asset turnover ratio in comparison to other companies in the same industry.
How can I improve my company’s asset turnover ratio?
The key to improving your total asset turnover ratio is improving total revenue while also spending less on assets. There are a number of ways in which you can work on this:
- replace inventory only when you have to
- embrace Just in Time inventory management
- use discounts and upselling techniques to liquidate slow-moving inventory
- use “Click & Collect” to improve customer foot traffic and increase upselling potential
- audit software costs regularly to ensure that your SaaS provisions are cost-efficient and fit-for-purpose
- augment opening hours to make your business more accessible to customers