A company sometimes invests big money in assets, such as equipment and inventory. When you own stock in a company, you want to make sure it squeezes as much sales revenue as it can from these resources. The asset turnover ratio measures the amount of revenue a company generates for every dollar of assets it owns. Reviewing this ratio for a single year provides limited information, but you can compare it over two or more years to help you identify any positive or negative trends in the company’s efficiency.
Step 1
Locate a company’s income statement and balance sheet in its Form 10-K annual report for each year you want to compare its asset turnover ratio. You can download a company’s Form 10-Ks from the investor relations section of its website or from the U.S. Securities and Exchange Commission’s online EDGAR database.
Step 2
Identify the amount of sales on each income statement. Find the amount of total assets on each balance sheet. For example, assume a company had $1.8 billion in sales in the most recent year and $1.5 billion in the previous year. Assume it had $750 million in total assets in the most recent year and $800 million in the previous year.
Step 3
Divide each year’s sales by its total assets to calculate each year’s asset turnover ratio. In this example, divide $1.8 billion by $750 million to get an asset turnover ratio of 2.4 in the most recent year. The ratio in the previous year is 1.88. This means the company generated $2.40 and $1.88 of sales for every $1 of assets it owned in each respective year.
Step 4
Check whether the asset turnover ratio increased or decreased from year to year. An increase suggests the company improved its efficiency and generated more sales per dollar of assets, while a decrease suggests the company’s efficiency declined. But each case requires further analysis to gain more insight. In this example, the asset turnover ratio increased from 1.88 to 2.4 from year to year, which suggests an increase in efficiency upon initial inspection.
Step 5
Analyze the changes in the asset turnover ratio’s components from year to year to determine the cause of an increase in the ratio. If rising sales led to an increase in the ratio, the company is likely in good shape. If sales and assets declined, but the overall ratio still increased, the company might be in trouble despite the higher ratio. In this example, sales grew from $1.5 billion to $1.8 billion, while assets declined, which means the overall ratio increase is good. The company generated more sales with fewer assets.
Step 6
Assess the changes in each ratio component to identify the cause of an overall decrease in the ratio. A declining ratio due to falling sales is a bad sign. On the other hand, if both sales and assets rise, but the ratio still declines, the weaker ratio might not be too bad. Say a company’s sales rise from $1.5 billion to $1.8 billion, while assets increase from $800 million to $1 billion. Its asset turnover ratio would fall from 1.88 to 1.8, which might be okay considering it invested in new assets and increased its sales.
References
Resources