Whether you are an accountant or a stock market enthusiast or somebody from a financial background, you must be familiar with the term Asset Turnover Ratio. However, if you aren’t, it’s still not a big deal because that’s why we are here.
So, without wasting any more words, let us start with the definition of asset turnover ratio.
The asset turnover ratio measures the value of a company’s revenues or sales in relation to the value of its assets. It is also referred to as the efficiency with which a company uses its assets to generate sales.
The higher the asset turnover ratio, the more efficient a company is at producing sales from its assets. This indicates that if the company’s asset turnover ratio is low, the company is not using its assets efficiently to generate sales.
The formula for the asset turnover ratio is as follows:
Asset turnover ratio = Net sales value/average of total assets
Net sales value denotes the amount of revenue/sales generated after deducting sales discounts, sales returns, and sales allowances.
Average total assets are the average of combined assets at the year-end of the present or preceding fiscal year.
Note: An analyst may use either average or end-of-period assets.
In general, a low asset turnover ratio causes troubles with poor inventory management, surplus production capacity, and bad tax collection methods. Low-margin industries are always more likely to have a higher asset turnover ratio.
Before proceeding ahead, I would like to draw your attention to a few blogs that you might be interested in reading:
To calculate the efficiency of capital deployment by a company, investors employ various types of asset turnover ratios. Some of the most common asset turnover ratio types are as follows:
Total asset turnover ratio
Fixed asset turnover ratio and
Net fixed asset turnover ratio (NFAT)
The total asset turnover ratio is the same as the asset turnover ratio which we have already discussed above. It matches the sales of a company to its asset base.
Total Asset Turnover Ratio = Net sales/Total assets
Suppose a company XYZ has a net sales of Rs. 10,00,000 and total assets of Rs. 5,00,000. Therefore, the total asset turnover ratio of the company will be 2.0. This calculation is mainly performed annually.
In general, the fixed asset turnover ratio is employed by analysts to assess operating performance. This efficiency ratio relates net sales to fixed assets and evaluates a company’s capacity to produce net sales from its fixed asset investments, namely property, plant, and equipment (PP&E).
Fixed Asset Turnover Ratio = Net Sales/ Average Fixed Assets
Net fixed asset turnover ratio denotes the pattern of operative productive assets such as plant and machinery after factoring in the wear and tear (depreciation). Also, it excludes assets that are held in form of investments in third parties, cash, etc.
Net Fixed Asset Turnover Ratio (NFAT) = Sales / Average of Net fixed assets at the start of the year and at the end of the year
A Net Fixed Assets Turnover Ratio of 1 symbolises that every incremental investment of ₹1 that a company makes in its plants and machinery would boost its sales by ₹1.
If a company has a high net fixed asset turnover ratio (NFAT), specifically with an NFAT of 4 or more suffers from high competition from the unorganized sector.