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Asset Turnover Ratio Definition

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Asset Turnover Ratio Definition

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What Is the Asset Turnover Ratio?

The asset turnover ratio measures the value of a company’s sales or revenues relative to the value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue.

The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets. Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to generate sales.

Key Takeaways

  • Asset turnover is the ratio of total sales or revenue to average assets.
  • This metric helps investors understand how effectively companies are using their assets to generate sales.
  • Investors use the asset turnover ratio to compare similar companies in the same sector or group.
  • A company’s asset turnover ratio can be impacted by large asset sales as well as significant asset purchases in a given year.

Formula and Calculation of the Asset Turnover Ratio

Below are the steps as well as the formula for calculating the asset turnover ratio.


Asset Turnover = Total Sales Beginning Assets   +   Ending Assets 2 where: Total Sales = Annual sales total Beginning Assets = Assets at start of year Ending Assets = Assets at end of year \begin{aligned} &\text{Asset Turnover} = \frac{ \text{Total Sales} }{ \frac { \text{Beginning Assets}\ +\ \text{Ending Assets} }{ 2 } } \\ &\textbf{where:}\\ &\text{Total Sales} = \text{Annual sales total} \\ &\text{Beginning Assets} = \text{Assets at start of year} \\ &\text{Ending Assets} = \text{Assets at end of year} \\ \end{aligned} ​Asset Turnover=2Beginning Assets + Ending Assets​Total Sales​where:Total Sales=Annual sales totalBeginning Assets=Assets at start of yearEnding Assets=Assets at end of year​

The asset turnover ratio uses the value of a company’s assets in the denominator of the formula. To determine the value of a company’s assets, the average value of the assets for the year needs to first be calculated.

  1. Locate the value of the company’s assets on the balance sheet as of the start of the year.
  2. Locate the ending balance or value of the company’s assets at the end of the year.
  3. Add the beginning asset value to the ending value and divide the sum by two, which will provide an average value of the assets for the year.
  4. Locate total sales—it could be listed as revenue—on the income statement.
  5. Divide total sales or revenue by the average value of the assets for the year.

What the Asset Turnover Ratio Can Tell You

Typically, the asset turnover ratio is calculated on an annual basis. The higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets.

The asset turnover ratio tends to be higher for companies in certain sectors than in others. Retail and consumer staples, for example, have relatively small asset bases but have high sales volume—thus, they have the highest average asset turnover ratio. Conversely, firms in sectors such as utilities and real estate have large asset bases and low asset turnover.

Since this ratio can vary widely from one industry to the next, comparing the asset turnover ratios of a retail company and a telecommunications company would not be very productive. Comparisons are only meaningful when they are made for different companies within the same sector.

Example of How to Use the Asset Turnover Ratio

Let’s calculate the asset turnover ratio for four companies in the retail and telecommunication-utilities sectors for FY 2020—Walmart Inc. (WMT), Target Corporation (TGT), AT&T Inc. (T), and Verizon Communications Inc. (VZ).

Asset Turnover Examples
($ Millions)   Walmart Target AT&T Verizon
Beginning Assets 219,295  42,779 551,669 291,727
Ending Assets 236,495  51,248 525,761 316,481
Avg. Total Assets 227,895 47,014 538,715 304,104
Revenue 524,000 93,561 171,760 128,292
Asset Turnover 2.3x 2.0x 0.32x 0.42x
Asset Turnover Examples

AT&T and Verizon have asset turnover ratios of less than one, which is typical for firms in the telecommunications-utilities sector. Since these companies have large asset bases, it is expected that they would slowly turn over their assets through sales.

Clearly, it would not make sense to compare the asset turnover ratios for Walmart and AT&T, since they operate in very different industries. But comparing the relative asset turnover ratios for AT&T compared with Verizon may provide a better estimate of which company is using assets more efficiently in that industry. From the table, Verizon turns over its assets at a faster rate than AT&T.

For every dollar in assets, Walmart generated $2.30 in sales, while Target generated $2.00. Target’s turnover could indicate that the retail company was experiencing sluggish sales or holding obsolete inventory.

Furthermore, its low turnover may also mean that the company has lax collection methods. The firm’s collection period may be too long, leading to higher accounts receivable. Target, Inc. could also not be using its assets efficiently: fixed assets such as property or equipment could be sitting idle or not being utilized to their full capacity.

Using the Asset Turnover Ratio With DuPont Analysis

The asset turnover ratio is a key component of DuPont analysis, a system that the DuPont Corporation began using during the 1920s to evaluate performance across corporate divisions. The first step of DuPont analysis breaks down return on equity (ROE) into three components, one of which is asset turnover, the other two being profit margin, and financial leverage. The first step of DuPont analysis can be illustrated as follows:


ROE = ( Net Income Revenue ) ⎵ Profit Margin × ( Revenue AA ) ⎵ Asset Turnover × ( AA AE ) ⎵ Financial Leverage where: AA = Average assets AE = Average equity \begin{aligned} &\text{ROE} = \underbrace{ \left ( \frac{ \text{Net Income} }{ \text{Revenue} } \right ) }_\text{Profit Margin} \times \underbrace{ \left ( \frac{ \text{Revenue} }{ \text{AA} } \right ) }_\text{Asset Turnover} \times \underbrace{ \left ( \frac{ \text{AA} }{ \text{AE} } \right ) }_\text{Financial Leverage} \\ &\textbf{where:}\\ &\text{AA} = \text{Average assets} \\ &\text{AE} = \text{Average equity} \\ \end{aligned} ​ROE=Profit Margin(RevenueNet Income​)​​×Asset Turnover(AARevenue​)​​×Financial Leverage(AEAA​)​​where:AA=Average assetsAE=Average equity​

Sometimes, investors and analysts are more interested in measuring how quickly a company turns its fixed assets or current assets into sales. In these cases, the analyst can use specific ratios, such as the fixed-asset turnover ratio or the working capital ratio to calculate the efficiency of these asset classes. The working capital ratio measures how well a company uses its financing from working capital to generate sales or revenue.

The Difference Between Asset Turnover and Fixed Asset Turnover

While the asset turnover ratio considers average total assets in the denominator, the fixed asset turnover ratio looks at only fixed assets. The fixed asset turnover ratio (FAT) is, in general, used by analysts to measure operating performance. This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures a company’s ability to generate net sales from its fixed-asset investments, namely property, plant, and equipment (PP&E).

The fixed asset balance is a used net of accumulated depreciation. Depreciation is the allocation of the cost of a fixed asset, which is spread out—or expensed—each year throughout the asset’s useful life. Typically, a higher fixed asset turnover ratio indicates that a company has more effectively utilized its investment in fixed assets to generate revenue.

Limitations of Using the Asset Turnover Ratio

While the asset turnover ratio should be used to compare stocks that are similar, the metric does not provide all of the detail that would be helpful for stock analysis. It is possible that a company’s asset turnover ratio in any single year differs substantially from previous or subsequent years. Investors should review the trend in the asset turnover ratio over time to determine whether asset usage is improving or deteriorating.

The asset turnover ratio may be artificially deflated when a company makes large asset purchases in anticipation of higher growth. Likewise, selling off assets to prepare for declining growth will artificially inflate the ratio. Also, many other factors (such as seasonality) can affect a company’s asset turnover ratio during periods shorter than a year.

What Is Asset Turnover Measuring?

The asset turnover ratio measures the efficiency of a company’s assets in generating revenue or sales. It compares the dollar amount of sales (revenues) to its total assets as an annualized percentage. Thus, to calculate the asset turnover ratio, divide net sales or revenue by the average total assets. One variation on this metric considers only a company’s fixed assets (the FAT ratio) instead of total assets.

Is It Better to Have a High or Low Asset Turnover?

Generally, a higher ratio is favored because it implies that the company is efficient in generating sales or revenues from its asset base. A lower ratio indicates that a company is not using its assets efficiently and may have internal problems.

What Is a Good Asset Turnover Value?

Asset turnover ratios vary across different industry sectors, so only the ratios of companies that are in the same sector should be compared. For example, retail or service sector companies have relatively small asset bases combined with high sales volume. This leads to a high average asset turnover ratio. Meanwhile, firms in sectors like utilities or manufacturing tend to have large asset bases, which translates to lower asset turnover.

How Can a Company Improve Its Asset Turnover Ratio?

A company may attempt to raise a low asset turnover ratio by stocking its shelves with highly salable items, replenishing inventory only when necessary, and augmenting its hours of operation to increase customer foot traffic and spike sales. Just-in-time (JIT) inventory management, for instance, is a system whereby a firm receives inputs as close as possible to when they are actually needed. So, if a car assembly plant needs to install airbags, it does not keep a stock of airbags on its shelves, but receives them as those cars come onto the assembly line.

Can Asset Turnover Be Gamed by a Company?

Like many other accounting figures, a company’s management can attempt to make its efficiency seem better on paper than it actually is. Selling off assets to prepare for declining growth, for instance, has the effect of artificially inflating the ratio. Changing depreciation methods for fixed assets can have a similar effect as it will change the accounting value of the firm’s assets.

The Bottom Line

The asset turnover ratio is a metric that compares revenues to assets. A high asset turnover ratio indicates a company that is exceptionally effective at extracting a high level of revenue from a relatively low number of assets. As with other business metrics, the asset turnover ratio is most effective when used to compare different companies in the same industry.

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Audit: What It Means in Finance and Accounting, 3 Main Types

Written by admin. Posted in A, Financial Terms Dictionary

Audit: What It Means in Finance and Accounting, 3 Main Types

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What Is an Audit?

The term audit usually refers to a financial statement audit. A financial audit is an objective examination and evaluation of the financial statements of an organization to make sure that the financial records are a fair and accurate representation of the transactions they claim to represent. The audit can be conducted internally by employees of the organization or externally by an outside Certified Public Accountant (CPA) firm.

Key Takeaways

  • There are three main types of audits: external audits, internal audits, and Internal Revenue Service (IRS) audits.
  • External audits are commonly performed by Certified Public Accounting (CPA) firms and result in an auditor’s opinion which is included in the audit report.
  • An unqualified, or clean, audit opinion means that the auditor has not identified any material misstatement as a result of his or her review of the financial statements.
  • External audits can include a review of both financial statements and a company’s internal controls.
  • Internal audits serve as a managerial tool to make improvements to processes and internal controls.

Understanding Audits

Almost all companies receive a yearly audit of their financial statements, such as the income statement, balance sheet, and cash flow statement. Lenders often require the results of an external audit annually as part of their debt covenants. For some companies, audits are a legal requirement due to the compelling incentives to intentionally misstate financial information in an attempt to commit fraud. As a result of the Sarbanes-Oxley Act (SOX) of 2002, publicly traded companies must also receive an evaluation of the effectiveness of their internal controls.

Standards for external audits performed in the United States, called the generally accepted auditing standards (GAAS), are set out by Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA). Additional rules for the audits of publicly traded companies are made by the Public Company Accounting Oversight Board (PCAOB), which was established as a result of SOX in 2002. A separate set of international standards, called the International Standards on Auditing (ISA), were set up by the International Auditing and Assurance Standards Board (IAASB).

Types of Audits

External Audits

Audits performed by outside parties can be extremely helpful in removing any bias in reviewing the state of a company’s financials. Financial audits seek to identify if there are any material misstatements in the financial statements. An unqualified, or clean, auditor’s opinion provides financial statement users with confidence that the financials are both accurate and complete. External audits, therefore, allow stakeholders to make better, more informed decisions related to the company being audited.

External auditors follow a set of standards different from that of the company or organization hiring them to do the work. The biggest difference between an internal and external audit is the concept of independence of the external auditor. When audits are performed by third parties, the resulting auditor’s opinion expressed on items being audited (a company’s financials, internal controls, or a system) can be candid and honest without it affecting daily work relationships within the company.

Internal Audits

Internal auditors are employed by the company or organization for whom they are performing an audit, and the resulting audit report is given directly to management and the board of directors. Consultant auditors, while not employed internally, use the standards of the company they are auditing as opposed to a separate set of standards. These types of auditors are used when an organization doesn’t have the in-house resources to audit certain parts of their own operations.

The results of the internal audit are used to make managerial changes and improvements to internal controls. The purpose of an internal audit is to ensure compliance with laws and regulations and to help maintain accurate and timely financial reporting and data collection. It also provides a benefit to management by identifying flaws in internal control or financial reporting prior to its review by external auditors.

Internal Revenue Service (IRS) Audits

The Internal Revenue Service (IRS) also routinely performs audits to verify the accuracy of a taxpayer’s return and specific transactions. When the IRS audits a person or company, it usually carries a negative connotation and is seen as evidence of some type of wrongdoing by the taxpayer. However, being selected for an audit is not necessarily indicative of any wrongdoing.

IRS audit selection is usually made by random statistical formulas that analyze a taxpayer’s return and compare it to similar returns. A taxpayer may also be selected for an audit if they have any dealings with another person or company who was found to have tax errors on their audit.

There are three possible IRS audit outcomes available: no change to the tax return, a change that is accepted by the taxpayer, or a change that the taxpayer disagrees with. If the change is accepted, the taxpayer may owe additional taxes or penalties. If the taxpayer disagrees, there is a process to follow that may include mediation or an appeal.

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Audit Risk Model: Explanation of Risk Assesment

Written by admin. Posted in A, Financial Terms Dictionary

Audit Risk Model: Explanation of Risk Assesment

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What Is an Auditor’s Report?

An auditor’s report is a written letter from the auditor containing their opinion on whether a company’s financial statements comply with generally accepted accounting principles (GAAP) and are free from material misstatement.

The independent and external audit report is typically published with the company’s annual report. The auditor’s report is important because banks and creditors require an audit of a company’s financial statements before lending to them.

Key Takeaways

  • The auditor’s report is a document containing the auditor’s opinion on whether a company’s financial statements comply with GAAP and are free from material misstatement.
  • The audit report is important because banks, creditors, and regulators require an audit of a company’s financial statements.
  • A clean audit report means a company followed accounting standards while an unqualified report means there might be errors.
  • An adverse report means that the financial statements might have had discrepancies, misrepresentations, and didn’t adhere to GAAP.

How an Auditor’s Report Works

An auditor’s report is a written letter attached to a company’s financial statements that expresses its opinion on a company’s compliance with standard accounting practices. The auditor’s report is required to be filed with a public company’s financial statements when reporting earnings to the Securities and Exchange Commission (SEC).

However, an auditor’s report is not an evaluation of whether a company is a good investment. Also, the audit report is not an analysis of the company’s earnings performance for the period. Instead, the report is merely a measure of the reliability of the financial statements.

The Components of an Auditor’s Report

The auditor’s letter follows a standard format, as established by generally accepted auditing standards (GAAS). A report usually consists of three paragraphs.

  • The first paragraph states the responsibilities of the auditor and directors.
  • The second paragraph contains the scope, stating that a set of standard accounting practices was the guide.
  • The third paragraph contains the auditor’s opinion.

An additional paragraph may inform the investor of the results of a separate audit on another function of the entity. The investor will key in on the third paragraph, where the opinion is stated.

The type of report issued will be dependent on the findings by the auditor. Below are the most common types of reports issued for companies.

Clean or Unqualified Report

A clean report means that the company’s financial records are free from material misstatement and conform to the guidelines set by GAAP. A majority of audits end in unqualified, or clean, opinions.

Qualified Opinion

A qualified opinion may be issued in one of two situations: first, if the financial statements contain material misstatements that are not pervasive; or second, if the auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion, but the possible effects of any material misstatements are not pervasive. For example, a mistake might have been made in calculating operating expenses or profit. Auditors typically state the specific reasons and areas where the issues are present so that the company can fix them.

Adverse Opinion

An adverse opinion means that the auditor has obtained sufficient audit evidence and concludes that misstatements in the financial statements are both material and pervasive. An adverse opinion is the worst possible outcome for a company and can have a lasting impact and legal ramifications if not corrected.

Regulators and investors will reject a company’s financial statements following an adverse opinion from an auditor. Also, if illegal activity exists, corporate officers might face criminal charges.

Disclaimer of Opinion

A disclaimer of opinion means that, for some reason, the auditor is unable to obtain sufficient audit evidence on which to base the opinion, and the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive. Examples can include when an auditor can’t be impartial or wasn’t allowed access to certain financial information.

Example of an Auditor’s Report

Excerpts from the audit report by Deloitte & Touche LLP for Starbucks Corporation, dated Nov. 15, 2019, follow.

Paragraph 1: Opinion on the Financial Statements

“We have audited the accompanying consolidated balance sheets of Starbucks Corporation and subsidiaries (the ‘Company’) as of September 29, 2019, and September 30, 2018, the related consolidated statements of earnings, comprehensive income, equity, and cash flows, for each of the three years in the period ended September 29, 2019, and the related notes (collectively referred to as the ‘financial statements’).

In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 29, 2019, and September 30, 2018, and the results of its operations and its cash flows for each of the three years in the period ended September 29, 2019, in conformity with accounting principles generally accepted in the United States of America.”

Paragraph 2: Basis for Opinion

“We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.”

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