The asset turnover ratio can be used as an indicator of how effectively a company uses its assets to generate revenue.

Use the following to calculate the asset turnover ratio: [latex]\dfrac{\text{net sales or revenue}}{\text{average total assets}}[/latex]

Note: Long-term investments are not usually included in the calculation because they are not productivity assets used to generate sales to customers.

In this case, we’ll reduce total assets by long-term investments. The adjusted long-term assets will be $2,004,000 for 2019 ($3,950,000-$1,946,000) and $1,784,000 ($3,606,000 – $1,822,000) for 2018, and the average of those two amounts is $1,894,000 (($2,004,000+$1,784,000)/2).

Sales of $994,000 divided by average total assets of $1,894,000 comes to 52.5%.

This ratio looks at the value of most of a company’s assets and how well they are leveraged to produce sales. The goal of owning the assets is to generate revenue that ultimately results in cash flow and profit.

The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets. Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to generate sales.

Sometimes, investors and analysts are more interested in measuring how quickly a company turns its fixed assets or current assets into sales. In these cases, the analyst can use specific ratios, such as the fixed-asset turnover ratio or the working capital ratio to calculate the efficiency of these asset classes.

While the asset turnover ratio considers average total assets in the denominator, the fixed asset turnover ratio looks at only fixed assets. The fixed asset turnover ratio (FAT) is, in general, used by analysts to measure operating performance. This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures a company’s ability to generate net sales from property, plant, and equipment (PP&E). The fixed asset balance is used net of accumulated depreciation. A higher fixed asset turnover ratio indicates that a company has more effectively utilized its investment in fixed assets to generate revenue.

The asset turnover ratio should be used to compare stocks that are similar and should be used in trend analysis to determine whether asset usage is improving or deteriorating.

The asset turnover ratio may be artificially deflated when a company makes large asset purchases in anticipation of higher growth. Likewise, selling off assets to prepare for declining growth will artificially inflate the ratio. Many other factors (such as seasonality) can also affect a company’s asset turnover ratio during interim periods (such as comparing quarterly results of a retailer).

Now, check your understanding of how to calculate the Asset Turnover ratio.