Total Asset Turnover

When evaluating the health of a company, its balance sheets are scrutinized. When it comes to studying balance sheets, it is all about numbers. One of the most important of these numbers is the total asset turnover ratio.

Definition

Let us define what do we mean by total turnover ratio and why is it an important financial parameter in accounting for any business. Total asset turnover relates to two factors that fuel the performance of a company. One is the assets and the other is the revenue or sales of the company. Simply put, it is the ratio of sales (Net Sales) of a company in a year, divided by the value of its assets. Why calculate such a ration? That's a question, which is bound to come to your mind. Let us see why.

The assets included the sum total value of fixed assets, accounts receivable for the company and total inventory valuation. In short, it is the total material investment value made in the company. Net sales is the revenue generated through sales, after accounting for any deductible items. The generation of sales, partially depends on how efficiently, the assets are used by a company. That's why, the ratio is calculated to account for the efficiency with which assets are used to generate sales.

How is it Calculated?

The formula is as follows.

Total Asset Turnover Ratio = Net Sales of the Company/Total Asset Value of the Company

All that you have to do is plug in the net sales number, along with total asset value in the above formula. Then it is just a matter of division. What is the significance of this ratio and how can it be analyzed. Let us have a look at that, in the next section.

Analysis

Running a business is all about generating value and increase profits. Profit is obviously, directly related to the sales that your company makes. It may be through the sale of a product or service offered. To create a product or generate a service, what is required is infrastructure and investment in material investment and human resources.

As a part of financial management, a company needs to analyze its balance sheets. When a company's asset turnover shows a rise, what it essentially means is that its net sales have increased. It also means that the investment a business has made in assets, is finally paying out. On the other hand, if there is a decline, then it indicates a pronounced drop in its sales. This drop may also be connected with under utilization of assets. The decline should be taken seriously and acted upon.

As I said before, it is an important financial parameter, that reflects how well the company has used its assets to improve its sales and revenue. If you are studying a company's performance for stock investing, it is important that you consider the ratio. Add it to your parameters of consideration when engaging in stock research. If it's your own company's performance, that you are analyzing, then a slump in total turnover asset ratio must be taken seriously.