Question

magine that you’ve been asked to explain one of the major accounting ratios to a group of high school students who have no background in business or accounting, but who are eager to learn. Describe how you would explain it in your own words, using a specific example: asset turnover

Answer 1

Definition: Asset turnover ratio is the ratio between the value of a company’s sales or revenues and the value of its assets. It is an indicator of the efficiency with which a company is deploying its assets to produce the revenue. Thus, asset turnover ratio can be a determinant of a company’s performance. The higher the ratio, the better is the company’s performance. Asset turnover ratio can be different from company to company. Usually, it is calculated on an annual basis for a specific financial year.

Description: Asset turnover ratio can be calculated by considering the average of the assets held by a company at the beginning of the year and at the end of a financial year and keeping the total number of assets as the denominator. The ratio can be higher for companies in certain sectors than others. For example, the retail sector yields the highest asset turnover ratio. According to a survey the retail sector scored an asset turnover ratio of 2.05 in 2014. Retail companies generally have small asset bases, but high sales volumes. The asset turnover ratio is a key constituent of DuPont analysis, a method the DuPont Corporation began using at some point in the 1920s. DuPont analysis basically breaks down return on equity into three parts, asset turnover, profit margin and financial leverage. The asset turnover ratio can be calculated by dividing the net sales value by the average of total assets.

Asset turnover = Net sales value/average of total assets

Generally, a low asset turnover ratio suggests problems with surplus production capacity, poor inventory management and bad tax collection methods. Low-margin industries always tend to have a higher asset turnover ratio.