Page 169 - CalcBus_Flipbook

CH 20] Calculating Business 20-13

Asset Turnover Ratio. This ratio measures how efficiently a firm uses its assets to
generate sales. This ratio is calculated by comparing Net Sales to Average Total Assets. The
equation for this calculation is:
Net Sales
Asset Turnover Ratio = ——————————
Average Total Assets

This ratio calculates net sales as a ratio of assets to show how many sales are generated
from each dollar of company assets. For instance, a ratio of 0.35 means that each dollar of
assets generates 35 cents of sales.
This ratio uses information from both a Comparative Income Statement and a
Comparative Balance Sheet developed on the same date; Net Sales from the Income
Statement and Average Total Assets from the Balance Sheet. Average total assets being
calculated by adding the beginning and ending Total Asset Balances together and dividing 20
this value by two. This is just a simple average based on the balance sheets of two
consecutive years.

Beginning Total Assets + Ending Total Assets
Average Total Assets = ———————————————————————
2

Analysis: The average total assets ratio measures how efficiently the firm uses its
assets to generate sales. A higher ratio is more favorable. A higher turnover ratio indicates
that the company is using its assets more efficiently. In perspective, two workers doing the
same job on their machine where one produces 12 units per hour and the other produces
16 units per hour. The higher producing worker is more efficient. The lower output worker
is less efficient, or taking more time to produce the same quantity of units. Similarly, for a
company, the lower the turnover ratio means that the company is using its assets less
efficiently and would indicate that there exists a problem with management or production,
or both.
If Average Turnover has a ratio of 1, this indicates that the net sales of a company
equals the average total assets for the year; the company is generating 1 dollar of sales for
every one dollar invested in assets. As with most ratios, the asset turnover ratio is based on
industry standards and some industries use assets more efficiently than others.
In the auto repair business, when the standard to replace an engine water pump is 1
hour 15 minutes and the mechanic completes the task in 45 minutes, this indicates that
the mechanic has an efficiency ratio of (75 minutes ÷ 45 minutes =) 1.67. The mechanic is
((1.67 – 1) x 100% =) 67% more efficient than the industry standard, and also indicates that
the mechanic is more profitable. This comparison is based on the industry standard of 1
hour 15 minutes (75 minutes) to replace an engine water pump. Again, the comparison is
against the industry standard. For mechanics, the repair job time standards are printed in
books that are available in a repair shop and their information is used to establish billing
rates to customers.
The total asset turnover ratio is an efficiency ratio that measures how efficiently a
company uses all of its assets. This affords investors an opportunity to gauge how well a
company is managed to produce products and sales. For creditors, utilizing the same gauge
gives a better idea of the likelihood that debt will be paid in a timely manner with generated
profits.
From this discussion it is easily understood that this ratio may be applied to all assets
or specific assets. Remember, that labor or equipment are assets that can be measured and
compared for their specific efficiencies; translating into profits.
Example: Roberta Carmona is starting a manufacturing company to stamp out control
and gauge panels that are installed in airplanes. Roberta is looking for new
investors and has a meeting with an investment group. This group wants to
know how well Roberta uses her assets to produce sales and asks for her
financial statements. Calculate the total asset turnover ratio when the
financials report:
 Beginning Assets: $150,000
 Ending Assets: $300,000
 Net Sales: $90,000

Copyrighted Material