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What is inventory turnover ratio

what is inventory turnover ratio

What is the total asset turnover ratio?

The total asset turnover ratio compares the sales of a company to its asset base. The ratio measures the ability of an organization to efficiently produce sales, and is typically used by third parties to evaluate the operations of a business.

Ideally, a company with a high total asset turnover ratio can operate with fewer assets than a less efficient competitor, and so requires less debt and equity to operate. The result should be a comparatively greater return to its shareholders.

The formula for total asset turnover is:

Net sales / Total assets = Total asset turnover

For example, a business that has net sales of $10,000,000 and total assets of $5,000,000 has a total asset turnover ratio of 2.0.

It is best to plot the ratio on a trend line, to spot significant changes over time. Also, compare it to the same ratio for competitors, which can indicate which other companies are being more efficient in wringing more sales from their assets.

There are several problems with the ratio, which are:

  • The measure assumes that additional sales are good, when in reality the true

    measure of performance is the ability to generate a profit from sales. Thus, a high turnover ratio does not necessarily result in more profits.

  • The ratio is only useful in the more capital-intensive industries, usually involving the production of goods. A services industry typically has a far smaller asset base, which makes the ratio less relevant.
  • A company may have chosen to outsource its production facilities, in which case it has a much lower asset base than its competitors. This can result in a much higher turnover level, even if the company is no more profitable than its competitors.
  • A company may be penalized for deliberately increasing its assets to improve its competitive posture, such as by increasing inventory levels in order to fulfill more customers orders within a short period of time.
  • The denominator includes accumulated depreciation, which varies based on a company's policy regarding the use of accelerated depreciation. This has nothing to do with actual performance, but can skew the results of the measurement.

In general, the return on assets measure is better than the total asset turnover ratio, since it places the emphasis on profits, rather than sales.

Related Topics

Category: Bank

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