Asset turnover, absolute asset turnover, gross asset turnover, or gross asset turnover is a financial measure that measures the efficiency of an organization’s use of its fixed assets in generating revenue over time. This term is often used as a measure of the financial health of the firm. Assets, such as fixed assets and human capital, are those resources that are fixed in the nature of the relationship between the firm and its external sources and cannot be changed or transferred. Firm income is the product of income from investment and net income from operations. The total fixed assets of a firm therefore equal the sum of its fixed assets plus its retained earnings.
Asset turnover occurs when one or more of the firm’s equity is disposed of. There are many different methods used to measure the rate of asset turnover. One of the most commonly used is the gross cost of capital. The gross cost of capital method is based on the current value of the present day value of all capital assets held by the company, less any liabilities (liabilities such as stock or mutual funds).
Another commonly used method of measuring asset turnover is the sales to capacity ratio. The sales to capacity ratio is the annual sales amount divided by the firm’s sales capacity per annum. If a firm has a high sales to capacity ratio, it would mean that the company is efficiently running its business. The sales to capacity ratio can also be calculated by dividing the gross sale amount by the number of accounts receivable. This ratio tells us how many accounts receivable units a firm has at any point of time.
Other important indicators of efficient asset turnover include the net sales ratio and the average sales per customer. The net sales ratio is the gross sales less total assets to sales. It can be calculated by dividing the gross sale by the number of customers that you have in your inventory. The average sales per customer reflects how many customers that you have per year. The more customers you have per year, the higher your average sales per customer. The net sales ratio tells us how well we are performing our tasks to generate sales for our firm.
The ratios between A and G can be plotted as a graph called the asset turnover cycle or turnover curve. These graphs show the relationship between levels of growth, the change in sales revenue, and the ratio of total assets to sales revenue over a period of time. The thicker the line, the better the performance.
If there is consistency in A and G, then we can conclude that the firms do not face any problems with their productivity. If A is positive and G is negative, then we can suspect that there is a problem. The best way to prevent problems is to have high levels of productivity. We can calculate the gross revenue to investment ratio by dividing the gross revenue by the cost of doing business. This will tell us what percentage of our total budget is going to the overhead cost and what percentage is going to capital expenses.
If the ratios are consistently poor, then we should examine how the management team is doing its job. We can use the KISS (Keep It Simple, Stupid) philosophy to make complex things simple. In this case, we are looking at the asset turnover ratio. If you are not keeping track of this ratio, you need to get it done and start analyzing your profit margins. If you find that the KISS principle is not followed, you may need to modify the management policy to increase cash flow and generate revenue.
The KISS principle holds true for any business. If the management does not know what to do with the asset turnover ratio, then it is likely they will not perform their duty to maximize sales returns. If the KISS is not followed, then the result will be lower profits, and the ability to keep shareholders happy will be in the business owner’s favor. Hopefully, now you have a better understanding of the importance of the KISS formula.