Asset Turnover Ratios: A Guide for Analysis

Is your business making the best possible use of its resources? Is what you’re getting out of your business increasing in line with what you’re putting in?

Your assets are key to this: machinery, equipment, company van, stock, cash, and even your office chair. With the help of asset turnover ratios, you can start to find answers. This may sound daunting, but step by step, it’s really quite straightforward. So, here’s how to do the maths, and what the outcome of your calculations might tell you about your business.

Total asset turnover ratio

We’ll start with the big picture, by looking at a relatively simple calculation. This can help you assess how everything within your business is being put to work to generate sales.

The calculation

1. Start by identifying and calculating the combined value of all of the assets within your business. For the purposes of this calculation, include not only tangible fixed assets, such as machinery and equipment, but also intangible fixed assets, such as patents, trademarks, and goodwill. The current net book value of these assets is applied, for example, after depreciation. Following this, include all current assets such as money owed by customers and money held by your business at the bank.
2. If possible, calculate your average total value of the assets for the period in question. Let’s say you are making the calculation on 31^st December. Calculate the value of your assets on that date. Subsequently, go back to 1^st January and look at the net value of your assets on that date. Add these figures together and divide them by 2.
3. Calculate your annual sales figure for the same period. For accuracy, if you are calculating the ratio for the year ending 31^st December (i.e. the calendar year), make sure that you take sales figures for that period only— don’t inadvertently apply the sales figures for the previous tax year, for example.
4. Calculate your net assets. You arrive at this figure by dividing the value of current liabilities by total assets. These liabilities are likely to include money owed to suppliers, loan repayments due within a year, and your outstanding tax bill – discount long-term liabilities such as loan capital due to be repaid after a year as these fall out of the period we are calculating.
5. Divide your sales figure by net assets to give your total asset turnover ratio. This is expressed as a ‘number of times per year’.

Here’s an example:

Sales revenue = £20,000

Net assets = £3,750

Total Asset Turnover Ratio = 5.3 times

What does this tell you?

For a small business, the total asset turnover ratio (like other similar ratios) really comes into its own when you compare one year’s figure to the next. For example, you could do the calculation just before you make several investments in new equipment. In broad terms, have those investments paid off? Should the following year’s ratio be higher, it might be evidence that they have.

Now, let’s say you haven’t made any big purchases. Your sales revenue has gone up, but the total sales turnover ratio has gone down. If you sell physical items, your inventory is often a culprit here. If so, are you lumbered with units that are not selling? It could be time to consider offloading these to a trade buyer.

Fixed asset turnover ratio

As your business grows, a big picture calculation such as the total asset turnover ratio can sometimes be a bit too general in helping you pinpoint precisely where things are going right or wrong. For instance, you might have purchased new machinery at the same time that you’ve acquired a valuable patent and a bulk load of stock. If it’s big, physical things you want to focus on, a more nuanced calculation is in order: the fixed asset turnover ratio.

The calculation

1. Calculate the average net value of your fixed tangible assets: machinery, equipment, and property. Intangible and current assets are not included here.
2. Calculate your annual sales figure for the same period.
3. Divide sales by net fixed assets to give the fixed asset turnover ratio.

What does this tell you?

If sales are steady, or increasing from one year to the next, but your ratio is going down, this could mean that your equipment is being under-used. A pattern of marked increases in this ratio can also be a cause for concern: it could mean that you are over-stretched and you may need to invest in new equipment to keep up with demands.

Working capital turnover ratio   

Is cash lingering in places where it could be put to better use? This is what the working capital turnover ratio can help you find out.

The calculation

1. Calculate the average value of your current assets for the year. This will include all cash, stock, and money owed by customers.
2. Calculate your working capital by subtracting average total current assets from average total liabilities – i.e. all debts you are expected to pay off within a year.
3. Calculate your annual sales figure for the same period.
4. Divide sales by working capital to give the Working Capital Turnover Ratio.

What does this tell you?

For a small business, this ratio can be useful for showing potential lenders that you are going to be able to keep up with repayments. A ratio of less than 1 indicates that your ‘must pay’ liabilities are frequently greater than your easily-accessible assets – a red flag for lenders. Generally, the higher your ratio, the more efficient you are at using your cash to generate sales. Beware though, if the ratio rises dramatically, this could be a sign that you do not have enough working capital available to support current growth levels.

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