In the simplest terms, your asset turnover ratio shows you how efficiently your company is using its assets to generate sales. It’s also an important ratio to know because your asset turnover ratio will likely be important to potential investors. Fortunately, calculating this ratio and using it is straightforward once you understand a few principles. To that end, this article will review the definition of the asset turnover ratio, its formula, and how you can improve your ratio.
The Formula and Definition of Asset Turnover RatioThe Corporate Finance Institute defines the asset turnover ratio formula as, “equal to net sales divided by the total or average assets of a company.” Expressed as a formula, the ratio looks like this: Of course, to use this formula you’ll need to know what your net sales and total assets are. To calculate net sales, you take your gross sales number and subtract all returns, discounts, and allowances. To get your total assets number, you can look on your company’s balance sheet.
Examples of Asset Turnover Ratios in ActionTo fully understand this ratio and how to use it, it’ll help to think through a couple of examples. So, for example, let’s say you wanted to use your asset turnover ratio to compare your company’s historical efficiency against its efficiency in 2020. In this case, you’d use the above formula to come up with two ratios. The first ratio would divide net sales from 2014 to 2019 by total assets for the same period. The second ratio would divide net sales by total assets for the year 2020. This is an important example because it shows how the period you use for net sales and total assets depends on what you’re trying to measure. It’s also important to understand this ratio from the perspective of an investor. Since they’re evaluating your company as an investment opportunity, they’re interested in how efficient your business is relative to others. So what they’ll often do is take your asset turnover ratio for a given period and compare it to other, similar companies. However, it’s critical to use the asset turnover ratio only for comparing similar companies. For example, it wouldn’t make sense to use this ratio for comparing a contracting business against a small chain of restaurants.
How You Can Improve Your Business’s Asset Turnover RatioSince your business’s asset turnover ratio is a measure of efficiency, it’s almost always a good idea to try to improve it. Put simply, the two ways you can improve your ratio are:
- Increase your net sales at a faster rate than your total assets.
- Decrease your total assets at a faster rate than your net sales.