Asset Turnover Ratio Defined
Asset turnover ratio is an efficiency ratio that is used to measure the efficiency of a company in generating revenue through the use of its assets.
A Little More on What is Asset Turnover Ratio
This ratio is used as a financial indicator which tells the efficiency of a company in the management of its assets. It is used to know the level of the assets’ rotation to identify the shortcomings and then enact improvements to maximize the use of the company’s resources.
The rotation of the assets means how long the assets take to become cash.
The Asset Turnover Ratio is calculated by taking the net turnover amount and then dividing it by the total assets. A high value of the ratio means that the productivity of the assets in generating sales is also high and so is the profitability of the business.
The Asset Turnover Ratio formula is given below:
Sales / Assets = Number of times
Assume a certain company’s assets in 2016 were 20,000,000 and the sales were 100,000,000. Calculate the Asset Turnover ratio.
100,000,000 / 20,000,000 = 5
In the above example, it means that the assets of the company rotated five times that year. Diving the number of days in a year by this number (365 / 5), we get 73 days as the time the assets take to rotate.
The same procedure can be used to calculate the rotation of fixed and current assets. This is done to get more specific results since total assets give a very general one which is not very useful. It is essential to separately itemize items like inventories and portfolio because they are the most sensitive elements of the assets.
Current assets usually are analyzed separately from non-current ones because they are designed to have a high turnover since they are assets solely dedicated for sale. This forces the search for the maximum possible rotation.
References for Asset Turnover Ratio
Academic Research on Asset Turnover Ratio
Using asset turnover and profit margin to forecast changes in profitability, Fairfield, P. M., & Yohn, T. L. (2001). Review of Accounting Studies, 6(4), 371-385. This paper attempts to prove that disaggregating the return on assets into asset turnover and profit margin doesn’t provide any increased information to use when forecasting the change in return on assets one year ahead. Instead, the paper claims that disaggregating the change in the return on assets into the change in asset turnover and profit margin, can be used to forecast a change in assets return one year ahead.
Agency costs, ownership structure, and corporate governance mechanisms, Singh, M., & Davidson III, W. N. (2003). Journal of Banking & Finance, 27(5), 793-816. This article extends the work done by Ang et al. [J. Finance 55 (1999) 81] onto other larger firms. It attempts to know whether there is a positive relation between managerial ownership and asset utilization even if it does -not as a significant deterrence to excessive discretionary expenses.
An empirical test of financial ratio analysis for small business failure prediction, Edmister, R. O. (1972). Journal of Financial and Quantitative analysis, 7(2), 1477-1493. This study develops and tests various methods that can be used to analyze financial ratios and predict the failure of small businesses. It further explains that even though all the ratios do not anticipate failure, most of the ratio variables are found to predict the collapse of Business Administration borrowers and the guarantee recipients.
The relationship between the environmental and economic performance of firms: an empirical analysis of the European paper industry, Wagner, M., Van Phu, N., Azomahou, T., & Wehrmeyer, W. (2002). Corporate Social Responsibility and Environmental Management, 9(3), 133-146. This paper investigates the relationship that exists between environmental and the economic performances of forms in the European industry of paper manufacturing. It then reports on a study that was conducted in the European paper industry.
Corporate social responsibility and financial performance, Cochran, P. L., & Wood, R. A. (1984). Academy of Management Journal, 27(1), 42-56. This study uses a new method, improved technique and industry-specific control groups to reexamine the relationship between corporate social responsibility and financial performance.
Multinationality and firm performance, Han, K. C., Lee, S. H., & Suk, D. Y. (1998). Multinational Business Review, 6(2), 63. This paper develops general insights into multinational relationships with the performance of the firm by studying the performance of firms in the seven most industrialized countries by using various methods of firm performance.
Financial ratios, discriminant analysis and the prediction of corporate bankruptcy, Altman, E. I. (1968). The journal of finance, 23(4), 589-609. This paper attempts to assess the quality of ratio analysis as an analytical technique by using the prediction of corporate bankruptcy as an illustration.
Ratio analysis and equity valuation: From research to practice, Nissim, D., & Penman, S. H. (2001). Review of accounting studies, 6(1), 109-154. This paper draws on recent research on accounting-based valuation to outline a financial statement analysis to be used in equity valuation. It incorporates standard profitability analysis and then complements it with an analysis of growth.
Stock market development and long-run growth, Levine, R., & Zervos, S. (1996). The World Bank Economic Review, 10(2), 323-339. This article investigates if there is a robust existing association between the development of the stock market and the long-run economic growth.
A short history of financial ratio analysis, Horrigan, J. O. (1968). The Accounting Review, 43(2), 284-294. This paper briefly explains how financial ratio analysis was developed and how it has advanced to the present time.
Some empirical bases of financial ratio analysis, Horrigan, J. O. (1965). The Accounting Review, 40(3), 558. This paper is aimed at bringing together scattered facts on financial ratio analysis and then provide a synthesis of the empirical bases of financial ratio analysis.