Your business's working capital is a cornerstone of financial success and growth. While calculating cash flow is crucial, it is also important to understand your company's total asset turnover ratio. This is a metric showing your organization's ability to use assets to generate sales. This is why we've compiled this short guide to the total asset turnover ratio and how to calculate it.
Asset turnover - explained
Your company's asset turnover ratio refers to the value of your business’s sales revenue relative to the value of your company’s assets. This means it can show how efficiently your company utilizes its assets to generate income. Most businesses calculate their total asset turnover ratio every year, however, you could also choose a shorter timeframe.
How to calculate the asset turnover rate for your business
The formula to calculate your company's asset turnover rate is as follows: Total Asset Turnover = Net Sales / Total Assets.
Of course, this requires you to identify your business's total assets and net sales. The formulas for those are as follows:
- Net Sales = Gross Sales – Returns – Discounts – Allowances
- Total Assets = Liabilities + Owner’s Equity
Company X makes GPB 300,000 in net sales. It has GPB 1,500,000 in total assets. The formula for their asset turnover rate is as follows: 300,000 / 1,500,000 = 0.20 x 100 = 20%.
Company X's assets can generate 20% of their net sales, relative to their value.
Interpreting your business's total asset turnover ratio
Put simply, high asset turnover ratios mean that a business is using its assets efficiently to generate revenue. A lower asset turnover ratio, on the other hand, indicates that a company is not efficient in generating revenue from its assets and generates more waste. Of course, the average assets turnover rate differs between industries. This means there is no defined figure for a “good” asset turnover ratio. For example, in the retail sector, an asset turnover ratio of 2.5 or more could be considered good, while a company in the utility sector can be happy with an asset turnover rate of c. 0.25-0.5.
If you are unhappy with your asset turnover rate, it is crucial to focus on improving net sales. This can be done through eg minimizing returns by stopping returns fraud and offering store credit instead of refunds. Of course, introducing new products or services is also likely to improve net sales.