Why does total asset turnover decrease?

The asset turnover ratio is an important financial ratio for understanding how well the company utilizes its assets to generate revenue. It is imperative for every company to analyze and improve the asset turnover ratio (ATR). The article highlights the reasons and ways to analyze and interpret asset turnover ratio as an important part of ratio analysis.

Definition of Asset Turnover Ratio

The asset turnover ratio determines the ability of a company to generate revenue from its assets by comparing the net sales of the company with the total assets. We calculate it by dividing net sales by the average total assets of a company. In other words, it aims to measure sales as a percentage of average assets to determine how much sales the company generates by each rupee of assets.

There can be several variants of this ratio depending on the type of assets considered to calculate the ratio, viz. with fixed assets, there is a fixed asset turnover ratio, and similar for current assets and total assets, capital intensity ratio which is reciprocal of this asset turnover ratio that helps in understanding it another way round.

How to Interpret Asset Turnover Ratio?

The asset turnover ratio shows the comparison between the net sales and the average assets of the company. An asset turnover ratio of 3 means for every 1 USD worth of assets and sales is 3 USD. So, a higher asset turnover ratio is preferable as it reflects more efficient asset utilization. However, as with other ratios, the asset turnover ratio needs to be analyzed while considering the industry standards.

Some industries are designed to use assets in a better way than others. A higher asset turnover ratio implies that the company is more efficient at using its assets. A low asset turnover ratio, on the other hand, reflects the bad management of assets by the company. As a result, it may also indicate production or management problems.

Why is it necessary to Improve Asset Turnover Ratio?

Since the asset turnover ratio measures the efficiency of a company in managing its resources to generate its sales, it is very obvious that higher turnover ratios are preferable for reflecting a better state of affairs at the company. This ratio gives insight to the creditors and investors into the company’s internal management. A low asset turnover ratio will surely signify excess production, bad inventory management, or poor collection practices. Thus, it is very important to improve the asset turnover ratio of a company.

How to Improve Asset Turnover Ratio

If a company analyzes that its asset turnover ratio is declining over time, there are several ways for improving the asset turnover ratio:

Increase in Revenue

The easiest way to improve the asset turnover ratio is to focus on increasing revenue. The assets might utilization be proper, but the sales could be slow, resulting in a low asset turnover ratio. The company needs to increase its sales through more promotions and quick movements of the finished goods.

Obsolete or unused assets should be liquidated quickly. Assets that are not used frequently should be analyzed to see whether there is a sense in retaining those. Basically, the company should sell those assets that do not add to the bottom line regularly.

Leasing

Another efficient way is to lease assets instead of buying them. Any leased equipment is not counted as a fixed asset.

Improve Efficiency

The asset turnover ratio could be low because of the inefficient use of assets. The company should analyze how it uses the assets and ways to improve the productivity of each asset. The output should increase without any significant increase in any other expenses.

Accelerate Accounts Receivables

The Slow collection of accounts receivables will lower the sales in the period, hence reducing the asset turnover ratio. The company should focus on quick collection practices. This can include outsourcing the delinquent accounts to a collection agency, hiring an employee just for collecting pending invoices, and reducing the amount of time given to customers to pay.

Better Inventory Management

The company needs to check its inventory management to figure out the time spent in the movement of the goods throughout the process. If the company’s delivery system is slow, there will be delays in getting the product to the customer and collecting the payment on time. So, the company should invest in technology and automate the order, billing, and inventory systems. This will improve sales and increase the asset turnover ratio.

Conclusion

Companies need to keep track of the asset turnover ratio. This ratio helps the company to measure how productive the business is. And how much revenue investment in the assets generates? A high asset turnover ratio is a sign of better and more efficient management of assets on hand. So, the companies need to analyze and improve their asset turnover ratio at regular intervals.

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1. Asset Turnover Ratio [Source]

Activity RatiosAsset TurnoverEfficiency RatiosRatio AnalysisTurnover Ratios

The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales from its assets by comparing net sales with average total assets. In other words, this ratio shows how efficiently a company can use its assets to generate sales.

The total asset turnover ratio calculates net sales as a percentage of assets to show how many sales are generated from each dollar of company assets. For instance, a ratio of .5 means that each dollar of assets generates 50 cents of sales.

Formula

The asset turnover ratio is calculated by dividing net sales by average total assets.

Net sales, found on the income statement, are used to calculate this ratio returns and refunds must be backed out of total sales to measure the truly measure the firm’s assets’ ability to generate sales.

Average total assets are usually calculated by adding the beginning and ending total asset balances together and dividing by two. This is just a simple average based on a two-year balance sheet. A more in-depth, weighted average calculation can be used, but it is not necessary.

Analysis

This ratio measures how efficiently a firm uses its assets to generate sales, so a higher ratio is always more favorable. Higher turnover ratios mean the company is using its assets more efficiently. Lower ratios mean that the company isn’t using its assets efficiently and most likely have management or production problems.

For instance, a ratio of 1 means that the net sales of a company equals the average total assets for the year. In other words, the company is generating 1 dollar of sales for every dollar invested in assets.

Like with most ratios, the asset turnover ratio is based on industry standards. Some industries use assets more efficiently than others. To get a true sense of how well a company’s assets are being used, it must be compared to other companies in its industry.

The total asset turnover ratio is a general efficiency ratio that measures how efficiently a company uses all of its assets. This gives investors and creditors an idea of how a company is managed and uses its assets to produce products and sales.

Sometimes investors also want to see how companies use more specific assets like fixed assets and current assets. The fixed asset turnover ratio and the working capital ratio are turnover ratios similar to the asset turnover ratio that are often used to calculate the efficiency of these asset classes.

Example

Sally’s Tech Company is a tech start up company that manufactures a new tablet computer. Sally is currently looking for new investors and has a meeting with an angel investor. The investor wants to know how well Sally uses her assets to produce sales, so he asks for her financial statements.

Here is what the financial statements reported:

• Beginning Assets: $50,000
• Ending Assets: $100,000
• Net Sales: $25,000

The total asset turnover ratio is calculated like this:

As you can see, Sally’s ratio is only .33. This means that for every dollar in assets, Sally only generates 33 cents. In other words, Sally’s start up in not very efficient with its use of assets.