Asset turnover is a measurement of a company's efficiency in terms of how well it turns its assets into sales revenue. The most common method of evaluating this aspect of a business is through a simple ratio reached by dividing a company's sales from a particular time period by its total assets in that same period. As a result, the asset turnover ratio, which is created from this equation, can be used to evaluate efficiency. It is important to realize that companies in different industries may be held to different demands in terms of the overhead they need to carry, so comparisons should only be done between similar companies.
There are many aspects of a business that interest investors who are deciding what to do with their capital. One of the most important aspects on which investors focus is efficiency. A company with copious assets that fails to capitalize on those assets with high sales totals is set up for eventual calamity. By contrast, a company with minimal assets that returns great sales is a potential breakout investment. As a result, evaluating asset turnover is a crucial tool for investors everywhere.
The asset turnover ratio is a method well-known among investors for measuring a company's ability to turn assets into sales revenue. Simply put, the higher the ratio, the more efficiently a company is performing. As an example of how this ratio works, imagine a company that has amassed $800,000 US Dollars (USD) in sales in a single year and holds assets of $1,000,000 USD at the same time. Dividing $800,000 USD by $1,000,000 USD leaves a ratio of .80, meaning that the company is producing 80 cents of sales for every single dollar of assets.
As is the case with any ratio, the asset turnover ratio is best utilized to compare companies within the same industries. For example, comparing the ratio of an international jewelry company with the ratio of a small, local grocery store would shed no light on the efficiency of either. Different industries and markets have different economic and operational realities influencing the efficiency of the companies within them.
One thing that asset turnover does tend to indicate is the pricing strategy of the company under analysis. In general, companies with high profit margins will have a low turnover ratio, and vice versa. This is because the companies in competitive industries like retail will price with an eye to outselling their market foes, thus creating high turnover.