What is Asset Turnover?
Asset turnover tells you how well a company uses its assets to make money. The company owns assets that have value, like machines, buildings, or furniture. The company uses these assets to make the products or services it sells.
Asset turnover is a number that shows how many times in a year the company uses up the value of its assets. A more significant number means the company is better at using its assets to bring in cash. A smaller number means the company could do a better job.
How to Figure Out Asset Turnover
To calculate asset turnover, you divide the sales the company makes in a year by the value of its assets. Here’s how it looks:
Asset Turnover = Sales / Assets
Let’s say GreatBiz had $100 million in sales last year. It owns $50 million worth of assets. To find asset turnover, do this math:
Asset Turnover = $100 million / $50 million = 2
This means GreatBiz used up the value of all its assets two times to get its sales last year. Two is a pretty good number for asset turnover.
An Example
Imagine two clothing stores at the mall – TrendyThreads and DullDuds. They have about the same assets, like clothing racks, dressing rooms, and cash registers. Let’s say they each have $500,000 in assets.
Last year, TrendyThreads sold $2 million worth of stylish outfits, while DullDuds sold $1 million worth of boring clothes.
For TrendyThreads, asset turnover is: $2 million / $500,000 = 4
For DullDuds, asset turnover is: $1 million / $500,000 = 2
TrendyThreads used up the value of its assets four times with its sales. DullDuds only used up its assets’ value two times. TrendyThreads is doing a way better job using what it has to make money!
Why Asset Turnover Matters
Asset turnover is significant because it shows how efficiently a company runs. Efficiency is all about getting the most out of what you have. A company with high asset turnover squeezes lots of sales from its assets. One with low turnover is letting its assets go to waste.
It’s All About the Profits
Companies want high asset turnover because it helps them make more profit. Profit is the money left after you subtract all the business costs. The whole point of a company is to make as much profit as possible.
Asset turnover boosts profits in two significant ways:
- More sales: When a company gets more sales out of the assets it already has, it brings in more money overall. More money coming in means more profit. It’s like a bakery finding a way to make more loaves of bread with the same oven.
- Lower costs: If a company uses its assets a lot, it doesn’t need to buy as many new ones. Things like machines and buildings cost a lot of money! Using what it has means less money going out to buy stuff. Lower costs mean higher profits.
So, higher asset turnover means more money coming in from sales and less money going out for assets. Both of those add up to fatter profits for the company. That’s why investors and managers get so excited about asset turnover!
Keeping Up with the Competition
Asset turnover also shows how a company is doing compared to others in its industry. Investors compare similar companies to see how they stack up.
Let’s go back to TrendyThreads and DullDuds. Pretend TrendyThreads is your company. You think turning over your assets four times is pretty awesome. But then you find out that most other clothing stores have a turnover of six! Suddenly, four doesn’t sound so great. Your company has some catching up to do.
But now imagine DullDuds is your company. You’re bummed that your turnover of 2 is way less than TrendyThreads’ 4. But then you find out that the average for boring clothing stores is only 1.5. Now your two look impressive! You’re beating most of your competitors.
Comparing asset turnover to other companies shows where you stand. Are you ahead of the pack or eating their dust? This info helps you figure out how to do better.
The Catch with Asset Turnover
Asset turnover is handy, but it doesn’t tell the whole story. It has a couple of problems you have to watch out for.
Out with the Old, in with the New
The first problem is that asset turnover measures the value of a company’s assets. But assets lose value as they age and wear out, a process called depreciation.
As assets depreciate, their value on the company’s books goes down. But the company didn’t lose them. It can still use them to make sales. So asset turnover might increase, but it’s not because the company has become more efficient. The assets just aren’t worth as much on paper.
Not All Assets Are Equal
The second problem is that some assets are more critical to making sales than others. A shoe factory needs machines a lot more than the CEO’s desk!
Asset turnover lumps all assets together. It can’t tell you if the crucial assets are being used well. A company’s asset turnover could be high overall while its most important assets are sitting idle, which is not a good sign.
Putting Asset Turnover to Work
Despite these issues, asset turnover is still a helpful tool. You just have to use it wisely. Here are some tips:
- Look at the trend: Track a company’s asset turnover over a few years. Is it going up? That could mean the company is learning to use its assets better. Is it going down? The company might have problems.
- Compare to competitors: See how a company’s asset turnover stacks up against others in the same industry. Is it higher or lower? This shows you if the company is outrunning its rivals or falling behind.
- Peek under the hood: Asset turnover is a high-level number. To understand a company, you must also dig into the details. Look at the specific assets and how they’re being used. The real insights are in the nitty-gritty.