What is the Total Asset Turnover Ratio?

The total asset turnover ratio compares the sales of a company to its asset base. The ratio measures the ability of an organization to efficiently produce sales, and is typically used by third parties to evaluate the operations of a business. Ideally, a company with a high total asset turnover ratio can operate with fewer assets than a less efficient competitor, and so requires less debt and equity to operate. The result should be a comparatively greater return to its shareholders.

How to Calculate the Total Asset Turnover Ratio

The formula for total asset turnover can be derived from information on an entity’s income statement and balance sheet. The calculation is as follows:

Net sales ÷ Total assets = Total asset turnover

It is best to plot the ratio on a trend line, to spot significant changes over time. Also, compare it to the same ratio for competitors, which can indicate which other companies are being more efficient in wringing more sales from their assets.

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Example of the Total Asset Turnover Ratio

Emerald Company operates a retail business and wants to evaluate its efficiency in using assets to generate sales. The company's financial data for the year is $5 million of net sales and average total assets of $2.5 million. Based on this information, its total asset turnover ratio is as follows:

$5 million net sales ÷ $2.5 million total assets = 2.0 Total asset turnover

A total asset turnover ratio of 2.0 means that Emerald generated $2 in sales for every $1 of assets. A higher ratio indicates greater efficiency in using assets to generate revenue, while a lower ratio may suggest underutilization of assets. For comparison, if a similar company in the same industry has a ratio of 1.5, then Emerald is performing better in asset utilization. However, if competitors have a ratio of 3.0, then Emerald may need to improve its operational efficiency to maximize revenue from its asset base.

Problems with the Total Asset Turnover Ratio

There are several problems with the total asset turnover ratio, which are as follows:

Incorrect indicator of performance. The ratio assumes that additional sales are good, when in reality the true measure of performance is the ability to generate a profit from sales. Thus, a high turnover ratio does not necessarily result in more profits.
Not useful for services businesses. The ratio is only useful in the more capital-intensive industries, usually involving the production of goods. A services industry typically has a far smaller asset base, which makes the ratio less relevant.
Depends on asset base. A company may have chosen to outsource its production facilities, in which case it has a much lower asset base than its competitors. This can result in a much higher turnover level, even if the company is no more profitable than its competitors.
Penalizes asset investments. A company may be penalized for deliberately increasing its assets to improve its competitive posture, such as by increasing inventory levels in order to fulfill more customer orders within a short period of time.
Skews reported results. The denominator includes accumulated depreciation, which varies based on a company's policy regarding the use of accelerated depreciation. This has nothing to do with actual performance, but can skew the results of the measurement.