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ACTIVITY RATIOS
ASSET TURNOVER RATIO

Introduction

Asset turnover ratio shows how well a company uses its assets to generate sales. The asset turnover ratio is expressed as a number and not as a ratio or percentage.

Asset Turnover Ratio  =          Sales Revenue
Assets

Example

For example if our fictional business Learnmanagement bookshop LM2 sales revenue is £10000 and the assets are worth £5000 then the asset turnover ratio is 2 i.e. 10000/5000 = 2

In general the higher the ratio the better, as the ratio shows how much money each asset unit is generating. If the asset turnover ratio is low it could mean that the assets are inefficient and not good at generating money. In other words you need lots of assets to generate a healthy sales revenue.

Conclusion

As with all financial ratios do not use just the ratios alone, to draw your full conclusion about the financial health of a business. For example a low asset turnover ratio could be due to the sales team’s performance, or the way the product is marketed rather than inefficient assets. Also if a firm's business activity requires capital reserves, it will have a low asset turnover ratio because capital is counted as an asset, even though it may not generate sales revenue. Whereas a firm based on labour and low capital reserves, will have a higher asset turnover ratio as labour (employees) are not categorised as an asset.

If you are comparing asset turnover ratios between different years for one business or asset turnover ratios for different businesses, for a fair comparison look at the impact of the following factors:

• What the assets are made up of, for example the mix between fixed and current assets
• Whether the business has bought new assets and the reason behind the purchase.
• What is causing the difference between the ratios? Is it the asset value or the sales turnover?

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