Q&A - Explain the asset turnover ratio

The asset turnover ratio considers the relationship between revenues and the total assets employed in a business. A business invests in assets (e.g. machinery, stocks) in order to make profitable sales, and a good way to think about the asset turnover ratio is imagining the business trying to make those assets work hard (or sweat) to generate sales.

The formula for asset turnover is:

In terms of where to get the numbers:

• Revenue obviously comes from the income statement (or profit and loss account)
• Net assets = total assets less total liabilities
• The resulting figure is expressed as a “number of times per year”

An example of this calculation is shown below:

Particular care needs to be taken when interpreting the asset turnover ratio. For example:

• The number will vary enormously from industry to industry. A capital-intensive business may have a much lower asset turnover than a business with low net assets but which generates high revenues.

• The asset turnover figure for a specific business can also vary significantly from year to year. For example, a business may invest heavily in new production capacity in one year (which would increase net assets) but the revenues from the extra capacity might not arise fully until the following year

• The asset turnover ratio takes no direct account of the profitability of the revenues generated