Study Notes: Business Finance & Accounting

Asset turnover

This ratio considers the relationship between revenues and the total assets employed in a business.  A business invests in assets (machinery, inventories etc) 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
• Net assets = total assets less total liabilities
• The resulting figure is expressed as a “number of times per year”

The calculation can be illustrated as follows using the follow balance sheet and income statement

How to evaluate the data in the table above?

At face-value, the asset turnover has deteriorated falling from 6.1 times per year to 4.8 times.  Why might this have occurred?

The best clues appear to be in the balance sheet.  The value of fixed assets has risen by over £300,000, the business has over £500,000 more cash and the value of loans has fallen.  That means that net assets have risen by almost 40%.

That certainly looks like good news.  However, revenues have only grown by 8%.  Hence the lower asset turnover – even though the story is a positive one!

You can see that particular care needs to be taken with 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