How to Calculate Net Asset Turnover?

Finance ManagementBanking & FinanceGrowth & Empowerment

What is the Asset Turnover Ratio?

The asset turnover ratio is a ratio that measures the ability of a firm to generate sales depending on its assets. It is calculated using net sales and average total assets. In other words, the net asset turnover ratio shows the efficiency of a company to convert its assets into sales.

As asset turnover is calculated as net sales of a percentage of assets, it shows how much sales have been made for each rupee of assets.

Example

Suppose a company ‘ABC Ltd’ is into the manufacturing of mobile phones and is in need for funding for expansion. ABC has approached an investor and the investor wants to check how well the company ABC utilizes its assets to generate sales.

Following are the figures that the company ABC has for the calculation of the same −

Beginning Asset Rs 60 Crore

Ending Inventory  = Rs 40 Crores

Net Sales = Rs 40 Crores

$$\mathrm{\mathrm{Asset\: Turnover}\:=\:\frac{\mathrm{Rs \:40\: Crore}}{\mathrm{\left ( Rs\: 60 \:Crore + Rs \:40\: Crore \right )}}\:=\:0.40}$$

Calculation of Asset Turnover Ratio

The Net Asset Turnover for a project can be calculated using the Asset Turnover Ratio. Whereas, the Asset Turnover Ratio is calculated by dividing Net Sales by Average Total Assets for a given period of time.

$$\mathrm{\mathrm{Asset\: Turnover}\:=\:\frac{\mathrm{Net\: Sales}}{\mathrm{Average \:Total\: Assets}}}$$

As there is a value of average total assets in the denominator, it needs to be calculated first. To do so, the opening balance of the year is added to the ending balance, and then the figure is divided by 2.

Steps to calculate the Asset Turnover ratio are as follows −

  • Locate the value of the company on its balance sheet at the beginning of the period.

  • Locate the ending balance or value of assets at the end of the year from the balance sheet

  • Find the average of the total assets by adding the beginning and ending balances and dividing the obtained figure by 2.

  • Locate the net sales figure on the income statement. It can be listed as revenue.

  • Divide net sales by the average of total assets to get the net asset turnover ratio.

Key Features of Asset Turnover Ratio

Some of the key features of Interval Ratio are as follows −

  • Measure Company’s Performance

    The asset turnover ratio is an excellent tool to measure the performance of a company in utilizing its assets to earn revenues. A higher ratio is always desirable because it shows that the company is more capable to generate sales from the same amount of assets in the long run.

  • Helps to Find out Main Issues

    A weaker asset turnover ratio suggests that there is a problem in converting assets into sales, and generating revenues for which production and management may be responsible.

  • Impact Due to Sale of Big or New Asset

    The asset turnover ratio can be impacted due to a sale of a large asset or a purchase of a new asset that has a considerable cost. Moreover, to understand the strength of companies in being capable of selling the assets and generating revenues, they must be from the same industry.

    For example, retail and electronics companies cannot be compared to check their asset turnover capabilities. If done so, they will show huge disparities.

Conclusion

Although asset turnover is an important tool for checking the basics of a company, it cannot reveal the most appropriate condition of a company when used alone. Therefore, like most other financial ratios, this efficiency ratio should also be used with other analyses to have an understanding of the condition of a company.

Moreover, as mentioned above, the industry chosen for two comparable companies should be the same.

For example, consumer electronics have a higher asset turnover than the retail industry. Companies from different industries should not be compared because the value of turnover of assets is different for different industries.

raja
Published on 12-May-2022 07:03:05
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