The Concept of Total Asset Turnover Explained

When evaluating the health of a company, its balance sheets are scrutinized. When it comes to studying them, it is all about numbers. One of the most important numbers is the total asset turnover ratio.

Total asset turnover relates to two factors that fuel the performance of a company. One is the assets and the other is the revenue or sales of the company. Simply put, it is the ratio of sales (Net Sales) of a company in a year, divided by the value of its assets.

The assets include the sum total value of fixed assets, accounts receivable for the company, and total inventory valuation. In short, it is the total material investment value made in the company.

Net sales is the revenue generated through sales, after accounting for any deductible items. The generation of sales, partially depends on how efficiently, the assets are used by a company. That's why, the ratio is calculated to account for the efficiency with which assets are used to generate sales.

The formula is as follows.

Total Asset Turnover Ratio = Net Sales of the Company/Total Asset Value of the Company

All that you have to do is plug in the net sales number, along with the total asset value, in the above formula. Then, it is just a matter of one division operation.

Running a business is all about generating value and increasing profits. Profit is directly related to the sales that your company makes. It may be through the sale of a product or service offered. To create a product or generate a service, what is required is infrastructure, material investment, and human resources.

As part of financial management, a company needs to analyze its balance sheets. When a company's asset turnover shows a rise, what it essentially means is that its net sales have increased. It also means that the investment which a business has made in assets, is finally paying out.

On the other hand, if there is a decline, then it indicates a pronounced drop in its sales. This drop may also be connected with underutilization of assets. The decline should be taken seriously and acted upon.

As I said before, it is an important financial parameter, that reflects how well the company has used its assets, to improve its sales and revenue. If you are studying a company's performance for stock investing, it is important that you consider the ratio.