Understanding Asset TurnoverThe Asset Turnover Ratio measures the amount of sales generated from each dollar of assets. It is a measure of how efficiently the company has used its assets to generate gross revenue. The higher the ratio the better. It is calculated as follows:
Total Assets on the December 31 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 Decemeber 31, 2006 was zero).
Total sales for the year are $144,000. Plugging these numbers into the formula,
we get $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 high profit margins tend to have lower ratios due to competitive pricing on sales, while companies with low profit margins tend to have higher ratios due to less competitive pricing. Sunny Sunglasses Shop has a Gross Margin of 70%. Recall that its main competitor also has high profit margins of 70%, while the industry average is 36%. 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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