Total Asset Turnover: Definition, Formula & Analysis

Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll explain total asset turnover and define each component of the formula. You'll also learn how to calculate the total asset turnover as well as how to analyze the results.

Total Asset Turnover

All Kind of Cupcakes opened 2 years ago and has grown into several franchises. With its enormous growth in sales, the company has had to hire several employees to help manage the business.

Jan was hired as the company's chief financial officer, and she brought on a team of analysts to review the company's financial health. She calls a meeting and tells the analysts they will calculate financial ratios and analyze the results. Financial ratios are a combination of two or more line items from financial statements joined by a mathematical operation.

The first financial ratio she mentions is the total asset turnover ratio, which is calculated by taking net sales/total assets. It tells us how efficiently a business is using its assets to generate sales.

For the rest of this lesson, we'll further explore the components of the total asset turnover formula and discuss how to analyze the ratio.

Sales

All Kind of Cupcakes only sell cupcakes. You'll find the company's sales, also called revenue, listed on the income statement. The total asset turnover formula shows the numerator as net sales, so what's the difference between sales and net sales? Net sales are simply sales minus any returns or discounts. One of the financial analysts raised his hand and asked, 'Why would someone want to return a cupcake?' Jan responds by explaining, 'A cupcake can be returned if someone is allergic to the ingredients or if the taste wasn't what they expected - good question'. Now let's move on to assets.

Assets

Assets are the items owned by All Kind of Cupcakes, such as the bakeries, inventory, land, administrative buildings and cash. Assets are listed on the balance sheet in two categories: current and long-term. Current assets are items that will be used, sold or consumed within a year. From the examples listed above, that would include inventory and cash. Long-term assets are those that may be used, sold or consumed in more than a year, such as the bakeries, land and administrative buildings.

Notice the total asset turnover formula lists the denominator as total assets. To find total assets, you would add current plus long-term assets. Now let's see how the ratio is calculated and analyzed.

Analysis

If All Kinds of Cupcakes has net sales of $750,000 and total assets of $1,000,000, its total asset turnover is 0.75. In sum, each dollar of assets generates 75 cents in sales. The higher the ratio, the more efficient the company is using its assets to make sales.

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