Using the Asset Turnover Ratio to Measure Asset EfficiencyIt is a measure of how efficiently the company has used its assets to generate revenue. The higher the ratio when compared to competitors or year to year trends, the more efficiently management has used company assets to generate revenue. Calculating the asset turnover ratio
Total assets on the December 31 examples of balance sheet are $101,008, which represents the asset ending balance for the period that we are measuring. Because the business started on January 1, 2007, there is no beginning asset balance (Beginning Asset Balance of January 1, 2007 = Ending Asset Balance for Prior Period of December 31, 2006, and the Asset Balance as of December 31, 2006 was zero). Total sales for the year are $144,000.
Sunny's asset turnover ratio equals $2.85. The next step, as always when calculating any financial ratio, is to add meaning to this number by comparing it with the industry averages:
Sunny Sunglasses Shop is earning $2.80 of gross sales for every $1 invested in assets, compared to $1.70 for the Specialty Retail Industry, and $1.00 for its closest competitor, Luxottica. Companies with lower asset turnover ratios tend to have higher profit margins since more assets are required to generate revenue which leads to less competition and the ability to raise prices. Conversely, companies with higher asset turnover ratios tend to have fewer assets required to generate revenue, and consequently, less barriers to entry. This leads to more competitive pricing and lower profit margins. Sunny Sunglasses Shop has used its assets more efficiently than both the Specialty Retail Industry and its competition which has the same strong gross profit margin of 70%.
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