Total Asset Turnover Definition & Formula
Table of Contents
- Total Asset Turnover Definition
- Total Asset Turnover Formula
- Interpreting the Total Asset Turnover
- Why do Investors Care About the Total Asset Turnover
- Real-Life Example of Using the Total Asset Turnover Ratio
- Ford's Big Turnaround
- Related Articles
Does the data in the above table mean anything to you? There are three key financial ratios listed: (1) net fixed asset turnover, (2) total asset turnover, and (3) equity turnover for Wal-Mart going back to January 2009. Well, if none of these ring a bell, by the end of this study, you will understand the significance of the total asset turnover ratio.
Total Asset Turnover Definition
The total asset turnover represents the amount of revenue generated by a company as a result of its assets on hand. This equation is a basic formula for measuring how efficiently a company is operating.
Total Asset Turnover Formula
Total Asset Turnover = Sales/Total Assets
While this article does a lovely job of displaying how the total asset turnover can impact a company's stock price, if you really want more information around how to calcualte the total asset turnover and some working examples, please visit total asset turnover examples.
Now that we have redirected all of the hardcore mathematicians, let's resume our breakdown of the total asset turnover ratio. The sales represents all the revenue generated by the company and is disclosed on a company's income statement. The total assets represent the assets listed on the company's balance sheet. The higher the ratio of sales to total assets, the better. This implies that a company is generating "x" number of sales for every dollar of assets on hand. For example if a company has sales of 1.5M and total assets of 5M, the company would have a total asset turnover ratio of .3 (1.5/5). Now looking at this number alone means very little. An investor must look at the turnover ratio relative to a company's competitors to determine how the company measures up in a common playing field. There are times when even comparing a company's total asset turnover to its peers is a fruitless activity as the company may be expanding its facilities which will drive future growth but will hurt on the short-term. We will be discussing a real-life example of this later in the article.
While this article does a lovely job of displaying how the total asset turnover can impact a company's stock price, if you really want more information around how to calcualte the total asset turnover formula and some working examples, please visit total asset turnover examples.
Interpreting the Total Asset Turnover
The total asset turnover is one of those simple calculations that speak volumes about the health of a company. This number is reported quarterly and can give an insight on whether a company is becoming more efficient at their core competencies over time. There is no set number that represents a good total asset turnover value because every industry has varying business models. One general rule of thumb is that the higher a company's asset turnover, the lower the profit margins, since the company is able to sell more products at a cheaper rate.
Based on what we know so far regarding total asset turnover, what conclusions can we draw from the above graph? Stating that the blue line is above the red line isn't enough. This graph shows a couple of key factors: (1) Wal-Mart is outperforming the consumer services industry in terms of getting its inventory off the shelf and (2) while the consumer services industry saw an uptick in 2009, Wal-Mart was able to match this growth. As an investor this gives you confidence that not only has Wal-Mart been able to out sell its competitors in the past, but it is also making great strides in the current year.
Why do Investors Care About the Total Asset Turnover?
What makes the total asset turnover a unique financial ratio is that it provides an investor some indication of the competitiveness in the market, as well as how efficiently a company is utilizing its assets to generate new sales. For example, let's say that the industry standard total asset turnover ratio for steel producing companies is .75. A fictitious company, Blue Steel has a total asset turnover ratio of 1.5. As an investor you can quickly see that Blue Steel is selling double its industry for the amount of assets it has on hand. The investor would of course have to look into the reason behind this success, but one could assume that Blue Steel has a product that competitors simply cannot offer, a great sales force, efficient production processes or all of the above.
Real Life Example of Using the Total Asset Turnover Ratio
As we mentioned in the earlier part of the article, looking at the total asset turnover ratio as a standalone indication of a company's financial health is not smart investing. Investors often look for a smoking gun in technical analysis or financial ratios but these charting techniques and numbers in isolation do very little to paint the picture of a company's health and vitality. To this point let's take a look at the total asset ratio of Human Genome Sciences; HGSI is a biotech stock which has struggled in recent years. The company is medium and size and has seen revenues increase in 4 of the last 5 years (2006: 25.76, 2007: $41.85M, 2008: $48.42M, 2009: $275.8M, 2010: $157.3M). Now looking at the numbers you can clearly see that something happened between 2009 and 2010 as this went completely counter to the accelerate revenue growth from previous years.
HGSI's total asset turnover relative to its Peers
The first thing we will want to do is determine how HGSI's total asset turnover fairs against other biotechnology companies. In this example we will use the following three companies for our analysis: Amgen (AMGN), Biogen Idec Inc (BIIB) and Emergent Biosolutions Inc, (EBS). Looking at the total asset turnover we see the below figures:
2010 Total Asset Turnover
So, from reading above we know that HGSI took a significant hit in revenues from 2009 - 2010 (-118.5M), has a relatively low total asset turnover relative to its peers and does not make as much money. The average investor at this point would probably pass on HGSI and call it a day. But we have to dig further. Why did HGSI's revenues drop so abruptly? Why is the total asset turnover much smaller than its competitors? If you do a quick Google search on HGSI, you will quickly see the word Benlysta. Benlysta is the first new drug for Lupus patients in over 50 years. Of course developing a new drug and completing the FDA approval process is not cheap. HGSI has had to invest millions in developing their commercial infrastructure and expanding their sales force team. However, on a positive note, analysts project there is a billion dollar market for Benlysta with no competitors, so how do you think this will impacts HGSI's total asset turnover?
Ford's Big Turnaround
Unless you have completely checked out of the financial world over the last 3 years, you would not have heard about Ford's Cinderella story of going from debt to profits. Now this process for Ford was painful. The company had to get better, cheaper and faster. To this point, Ford had to reduce the number of cars in its product line as well as shed thousands of jobs. Now to try and understand all of these changes and their impact on the company's bottom-line on a micro level would have been challenging to say the least. Now before we get into the charts, let me say that this is a homerun example for analyzing the total asset turnover of the company. In the vast majority of the cases, a company's turnaround story can take a decade and is pretty gradual. Ford did not have this luxury as the company was on the brink of bankruptcy.
Ok. So, maybe the fonts above are a bit small to read. But if you care enough to strain your eyes, you will notice that the average asset turnover was increased from a range of .5 - .6 to over .7. Now let's take it a step further and do a comparison of the total assets to revenue.
At times it is good to step away from the ratios and look at the hard data. Now remember, for total asset turnover we are focused on the company's sales and net total assets. In the above chart you will notice that the blue line (revenue) is pretty much flat for the past 9 years. There was a recent dip since 2008, but the revenue is on the uptick from early 2009. Conversely, the orange line (total assets) took a sharp nosedive in early 2008 as a result of the economic recession and needing to cut costs. So, what do you think happens when a company maintains revenue levels, while drastically reducing its assets?
If you guessed the stock price rises, you are correct! The one thing to note about financial ratios is that they take time to have an impact on the price of the stock. Look at how Ford cut their assets by a third, yet it took the stock months to have any sort of price reaction. So, if you are a trader looking to get in and out of the market quickly, you may have to wait it out for the rest of the world to realize what you were able to discern from the financial numbers.
In summary the total asset turnover ratio can speak volumes about a company's ability to make money in terms of the total assets on the books. The key thing to note is that this number is a lagging indicator and does not provide much in terms of potential for future earnings.
To learn more about various financial ratios and how they may impact your investment decisions, please visit the financial ratios hub page. Here you will find high quality articles on topics such as accounts receivable turnover ratio, book to market ratio and liquidity ratios.