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Calculate Turnover Ratios

Use turnover ratios to see if a company’s management is using its assets effectively to generate profits.

Every company management team aims to deploy its assets to generate the most profits possible. It doesn’t do any good for a company to own assets, such as factories, inventory, or even cash, if they’re not being used to maximum advantage. There are three ratios that investors typically evaluate to measure the efficiency of company management: asset turnover ratio, inventory turnover ratio, and receivable turnover ratio.

Asset Turnover Ratio

The first ratio to consider is the asset turnover ratio, which assesses the sales that a company can generate for each dollar of assets it owns—the higher the asset turnover ratio, the better. Companies with high asset turnover ratios can thrive even with low profit margins.

The asset turnover ratio is calculated using the formula in Example 4-36.

Example 4-36. Formula for the asset turnover ratio

Asset Turnover Ratio = Total Revenue for Period / Average Assets for Period

Companies report the value of their assets on their balance sheets included in the financial statement section of their SEC 10-Q and 10-K filings. However, they report the value of those assets as they stood at the end of the year. You can calculate the average assets for the period by averaging the year-end values for total assets for the current and previous years.

Tip

You can use total assets in place of average assets, mostly for the sake of simplicity. ...