The ratio of turnover is a useful tool to analyse your business performance. These ratios let you look at and compare previous years' ratios to the most current ratios. This comparison will assist you in determining the areas where you may need to make changes. It can also evaluate your business against industry standards to determine how your business compares.
The ratio of total asset turnover is a number that measures how much you make in net income to the total assets. It's a measure of how your assets contribute to sales, and we can calculate it by analysing your finances.
A high percentage of total asset turnover indicates that your asset is doing effectively for you, while a lower ratio indicates the opposite. A higher ratio is more favourable, but it's contingent on the nature of your business and the industry in which you work.
Did you know?
If you want to calculate turnover on your balance sheet, then the process is simple. First, locate the inventory's value on the balance sheet from the current and previous accounting periods. Add both the inventory values and divide by two, and you'll get the average amount of inventory. To calculate inventory turnover, divide your average inventory into COGS.
What Is the Significance of the Asset Turnover Ratio?
After knowing about the asset turnover ratio meaning, let's see what the turnover of assets is. One of the many indicators you can use to assess a company's efficiency is its asset turnover ratio. This ratio is usually calculated annually and measures the company's sales from every rupee of assets. A higher asset turnover ratio means that the company is more efficient.
However, a lower ratio could indicate inefficiencies within company operations (e.g. billing and store management). Many creditors and investors use this ratio analysis to evaluate a company's potential growth and liabilities.
What Is Asset Turnover Ratio?
The asset turnover ratio is a comparison of sales revenues and total assets. Although it may seem simple, the asset turnover ratio provides insight into your business operations, influencing future decisions.
As an example, you would have assets if you were a business owner.
These assets could include a checking and savings account, a computer or a printer. However, larger businesses might have many assets, such as a building, an equipment plant, equipment machinery, multiple bank accounts and a credit line.
Calculating the asset turnover ratio, in either case, will give you an indication of how efficient you are using your assets.
The Turnover of Assets and Profit
The return on assets ratio is a common profitability measure, and it measures how well an organisation uses its assets to generate profit. This is how the return on assets measures how a good company uses its assets to produce a profit.
It does not include sales revenue. The exact income you divide by entire average assets is the formula for return on assets. Organisations with high asset turnover will have lower profit margins, and conversely, those with low turnover will have greater profit margins. Also, while you receive online payments, there are chances of facing QR scams. Therefore, avoid it and pay attention to security by reading about QR code scams.
How Can I Use Asset Turnover Ratio?
For evaluating companies, asset turnover ratios can be a valuable tool.
1. To Improve Efficiency
Companies looking to improve their efficiency will want higher ratios. Companies can use lower ratios to identify poor inventory management, substandard collection or improper asset use. They can further implement new strategies to improve efficiency.
2. To Compare Companies
Do not compare the asset turnover ratios of companies in the different industries. Different industries have different turnover rates.
3. For DuPont Analysis
DuPont analysis analyses a company's Return on Equity (ROE) and its net income relative to its total equity. This analysis considers profit margin, financial leverage and asset turnover ratio.
How to Calculate Asset Turnover Ratio?
Find the correct inputs to calculate the efficiency ratio and correctly use the asset turnover formula.
1. Identify the Numbers You Need.
Locate the financial statements for a company's year. Find the company's beginning assets and ending assets on the balance sheet. The income statement identifies the company's total sales for the year.
2. Calculate the Average Assets
Add the ending assets to the beginning assets to calculate the average total assets. Divide the sum by 2. This is your average total assets.
3. Divide Total Sales by the Average Total Assets.
Place the average total assets in the numerator below your total sales. Divide your total sales by the average of all assets. This is the asset turnover ratio.
4. Interpreting the Ratio
You can only use ratios when comparing them with the same ratio from the past or another company in the same industry. The industry ratio can also help make the comparison, but it will not be as accurate because of how businesses in the same industry can operate.
The companies must have similar cost structures or products and services when comparing their total asset turnover ratios. A company should be comparable in revenue, assets and geographical location.
A comparison of asset turnover ratios might not prove useful if you have local suppliers and your trucks are running the supplies. Still, your competitor is getting suppliers from out-of-state with their trucks. In such conditions, the comparison will be useless. This would allow you to compare your business' performance over time.
Also Read: Accounting Ratios – Meaning, Types, Formulas
The Ratio Formula Elements
Two factors are vital to calculating the asset turnover ratio. The company's net sales (gross sales before accounting for returns, allowances and discounts) and its total assets (equity and liabilities at the start of the year, + the total at year-end). We can express this formula as follows:
Asset Turnover Ratio = Net Sales / Total Assets
A company's financial statements will contain the formula's components (net sale and total assets). For total sales, you can use the company's income statement to determine the net sales value for the year. You could also record it as revenue. This figure should include all allowances, returns, discounts and other expenses.
To calculate the annual average value of company assets:
- Check out its balance sheet for the value of its assets at the year's beginning.
- You should assess the company's assets value at the end of each year.
- Divide the total assets for the year by 2, after adding the ending and beginning values.
The total assets denominate the asset turnover ratio.
How to Increase Asset Turnover Ratio by Industry?
There are many ways to improve the asset turnover ratio of a company whose asset turnover ratio has been declining over time.
Leasing assets is a more efficient option than buying them. Leased equipment does not count as a fixed asset.
Inefficient asset use could lead to a low asset turnover ratio. The company needs to analyse the use of its assets and find ways to increase the productivity of each asset. Without any significant increase in other expenses, the output should rise.
The best way to increase revenue is to focus your efforts on improving the asset turnover ratio. If it's low, it results from poor asset utilisation or slow sales. Increase sales by promoting more and moving the goods quickly.
It is important to dispose of obsolete or unutilised assets quickly. Assets not used often should be evaluated to determine if it makes sense to keep them. The company should dispose of assets that are not adding value to its bottom line.
Better Inventory Management
To determine the time it takes to move the goods through the supply chain, the company must review its inventory management. Slow delivery systems can delay getting products to customers and collecting payments on time. The company should invest in technology to automate order, billing and inventory processes, increasing sales and improving the asset turnover ratio.
Accelerate Accounts Receivables
Slowly collecting accounts receivables can reduce sales and decrease asset turnover. It is important to focus on fast collection. You can outsource the accounts to a collection agency or hire an employee to collect the pending invoices, and this will reduce the time given to the buyers to pay.
You understand the asset turnover ratio meaning now. Be aware that you can reduce the turnover ratio when an organisation makes a massive purchase of assets to prepare for greater growth.
Also, selling assets to deal with the falling growth could artificially boost the ratio. Other factors (such as seasonality) could also impact the asset turnover ratio during interim periods (such as comparing the retailer's quarterly results).
A business requires so many online transactions, and later on, it becomes so hard to calculate them all to measure profit and loss. Therefore, use Khatabook to keep it all automated.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.