The asset turnover ratio is a part of the efficiency ratios that calculates if a company is able to bring in sales from its assets by putting net sales with average total assets into comparison. Simply put, this ratio reflects how effectively a company utilises its assets to bring in sales.

The total asset turnover ratio measures net sales as a percentage of assets to show the number of sales generated from each dollar of assets of the company. For example, a ratio of .6 shows that each dollar of assets generates 60 cents of sales.

The formula to calculate Asset Turnover Ratio is:

Asset Turnover Ratio = Net Sales/Average Total Assets

Implication

The ratio calculates how effectively a firm utilises its assets to bring in sales, so a higher ratio is always more beneficial. Higher turnover ratios suggests that the company is making a good use of its assets. Lower the ratios, lower the efficiency of the usage of the assets and clear indication of either mismanagement or problems in production.

For example: a ratio of 1 suggests that the net sales of a company is equal to the average total assets for the year. Simply put, the company is brining in 1 dollar of sales for every dollar invested in assets.

To get a clear picture of how effeiciently a company is using its current assets, it should be compared to the companies within the same industry.

Example

Wendy’s tech company is a start up company that manufactures computers. Wendy is lately looking for new investors and has a meeting with one of the investors. The investor wants to get a clear picture of how effeciently Wendy uses her assets to produce sales, so he asks for her financial statements.

Here is what the financial statements reflected:

Beginning Assets: $50,000

Ending Assets: $100,000

Net Sales: $25,000

Putting in the formula

Asset Turnover Ratio = Net Sales/Average Total Assets

ATR = $25,000/($50,000 + $1,00,000)/2

ATR = 0.33

The figure 0.33 suggests that for every dollar in assets, Wnedy only brings back in 33 cents. Simply put, Wendy’s start up is not effective enough with the usage of assets.