In business, businesses often rely on total asset turnover ratio To be able to evaluate the overall performance of your business process.
In the article below, lamchutaichinh.vn will help you learn more about total asset turnover What is it and how to apply it in practice.
Table of Contents
What is total asset turnover?
Score total asset turnover (Total Asset Turnover Ratio) is a measure showing the efficiency in operating and developing a business by measuring revenue or sales compared to the value of assets of the business.
When an enterprise invests its assets in production and business activities, this ratio will show how much cash flow the business invests in for each cash flow that brings in revenue.
The higher the total asset turnover ratio, the more effective the enterprise’s assets are used in production and business activities. On the contrary, if the turnover ratio is low, this shows that the business when investing assets to do business has not really been effective to generate cash flow.
How good is the total asset turnover ratio in business operations?
Usually, a business and company with a higher total asset turnover ratio shows that the business and company is doing well and bringing efficiency, generating more revenue and more money flowing in.
However, we need to note that this ratio in each different business type reflects different efficiency. In particular, businesses operating in the field of retail or normal services such as entertainment, consulting, event organization, etc., the ratio tends to be higher than that of other industries.
This is because the sales volume of the products of these industries is usually high but the asset base (including tangible assets such as plant, land, machinery, cash, cash equivalents, etc.) …) is small. In addition, businesses in sectors such as utilities and real estate have a large asset base but a lower asset turnover ratio.
Therefore, the comparison only makes sense when made for companies in the same industry or compared with the business’s own business in the previous period.
Formula to calculate total asset turnover (Total Asset Turnover Ratio)
To calculate total asset turnoverwe rely on the formula:
- Total sales (Total sales): The business’s revenue is obtained after deducting taxes, expenses, sales discounts, sales discounts, sales allowances, etc.
- Total average assets: Is the total assets at the beginning of the period (Beginning assets) plus the total assets at the end of the following period (Ending assets) and then divided by 2.
Calculation steps include:
- First, businesses need to determine the value of assets based on the balance sheet at the beginning of the year.
- Determine the balance, the final value of the assets of the business at the end of the year.
- Add the initial asset value and the final asset value together and divide by 2 to get the average asset value for the year.
- Next determine the total sales, which can be listed as revenue in the income statement.
- As a final step, divide total sales or sales by the average asset value for the year.
Meaning of total asset turnover ratio
A business’s total asset turnover ratio is usually calculated on an annual basis or within a given business cycle. This is also an important indicator that businesses are often interested in analyzing over many business periods.
From this index, investors can estimate the rate of return (ROI) when making investments in assets, etc. Especially for companies, large corporations, enterprises operating in the manufacturing sector. Production and business must buy a large amount of machinery and equipment, which costs a lot of money.
This index helps businesses evaluate the results of their production and business activities as well as the operation and development of the organization compared to competitors in the industry. From there, change and overcome the strategy of using assets and capital in a reasonable way to improve the performance and revenue of the business.
Performance indicators that businesses need to know
To be able to understand clearly whether the financial performance of the business has not been effective or not, what problems need to be overcome, modified in operation, etc., the enterprise needs to properly evaluate the effectiveness of the business. operating efficiency, asset transfer, cash flow, goods to accurately determine the total asset turnover.
Performance indicators are shown through:
Managing inventory turnover will help businesses easily control their production activities. Inventory turnover shows the number of times the average inventory is turned over during a business period, which is determined by the formula:
Inventory Turnover = Sales/Average Inventory
The higher the inventory turnover ratio, the faster and efficient the business and the less backlogged goods. This also minimizes the risk of inventory management.
On the contrary, if this index is too high, it will also affect the timely response of businesses to the needs of customers.
Accounts Receivables Turnover
This is the cycle that shows the debt management status and the ability to recover capital in the business periods of the enterprise. Calculated by the formula:
Accounts Receivable Turnover = Net Sales/Average Receivables
The higher the receivables turnover ratio, the better the ability to collect debts from suppliers, customers, and partners. These are reputable partners and suppliers that businesses can cooperate with for a long time.
However, if this index is too low, the enterprise is likely to fall into the situation of capital misappropriation, not being able to collect debts, having many problems with suppliers or partners, etc., affecting the process. business.
Long-term asset turnover
Long-term asset turnover is the long-term assets used in the business, including machinery, equipment, buildings, etc.
This turnover shows how much revenue the business will earn for each cash flow when investing in long-term assets, expressed by the formula:
Long-term asset turnover = Net sales/Average total long-term assets
What is the difference between total asset turnover and fixed asset turnover?
“What is the difference between total asset turnover and fixed asset turnover?” This is a question that many people wonder.
Total asset turnover ratio shows the ability of a business to generate revenue from its investment in total assets. The total assets of a business include all resources that the business owns, which can be short-, medium-term or long-term assets of the business.
Most businesses operating in capital-intensive industries need to invest a lot in machinery, locations, equipment, etc. to produce goods and services to meet service needs such as telecommunications, filtration. oil, etc. usually has a lower total asset turnover ratio than other industries.
It can be said that fixed asset turnover is similar to total asset turnover, the biggest difference is that the fixed asset turnover index focuses mainly on fixed assets.
The reason is because this is also the type of asset that accounts for a large proportion of the business. Fixed asset turnover is like a “metric” for business owners and investors to use to evaluate the effectiveness of the business model of an enterprise.
How to improve the total asset turnover index?
So how can a business improve its total asset turnover ratio?
Check out a few ways below:
- Businesses can improve turnover rates by stocking high-sellable items on shelves and replenishing inventory only when needed. Besides, businesses can increase uptime to increase the number of customers as well as increase sales.
- In addition, businesses can apply the Just In Time (JIT) method in the Lean Management model (Lean). This is a way to reduce waste and reduce inventory, by meeting the right customer needs in terms of product, quantity, type, place and time.
Eg: When an auto assembly plant needs to install airbags, they don’t keep an inventory of airbags on their shelves, but pick them up as the cars go onto the assembly line.
Limitations of the total asset turnover ratio Enterprises should know
Each financial indicator has certain limitations, the total asset turnover index is no exception. Detail:
- It is not possible to provide a complete picture of the financial position of the business. To get an overview and make the most accurate investment decisions, investors and business owners need to combine the study of this index with other financial indicators.
- May be adjusted because the business has sold or rotated machinery, equipment, etc. to increase the total asset turnover index. Besides, changing the method of calculating the depreciation of fixed assets will also have the same impact.
- May be affected by seasonality, asset turnover of the business in a short time.
- The ratio comparison is not meaningful for companies in the opposite industry because depending on the characteristics, each industry will have different asset base requirements.
Through the above article, lamchutaichinh.vn has provided detailed information about total asset turnover, calculation formula and important notes to understand. This is an important financial indicator that anyone operating in the business or planning to invest needs to study and consider carefully.
Hopefully through this article you will be able to gain useful knowledge and make effective business and investment options.
Information edited by Lamchutaichinh.vn