Companies With High Asset Turnover & Low Profit Margin
Managing a small business can be a balancing act between sales price and volume. One way to increase sales is to lower prices, but lowering prices drives down margin. In a perfect world, an increase in one doesn't call for a decrease in the other, but the world of small business is filled with imperfections. While these imperfections can seem daunting, you can use them to your advantage if you understand the right levers to pull.
Return on assets, commonly called ROA, is a measure of operational efficiency and is calculated by dividing net income by total assets. ROA is also calculated by finding the product of profit margin and asset turnover. Profit margin is how much of net sales you managed to keep as profits, and asset turnover is the pace at which you sell product. The former is a function of prices and costs; the latter is a function of supply and demand. A company with high asset turnover can still generate a high ROA even if net income is low. In fact, this is a common pricing strategy for discount retailers.
Net income is defined as sales minus all the costs and expenses associated with doing business. A business can grow net income by increasing the sales price on products or services, or by decreasing the costs and expenses associated with those products or services. For example, if a company selling chairs needs to increase net income, it can increase the price of chairs, or decrease the amount it pays labor on the production of chairs, or both.
Asset turnover is another way to say volume or number of units sold. It is calculated by dividing sales by total assets. In general, the more volume your business can sell, the more income it will make due to economies of scale. If a business wants to increase volume, it can temporarily decrease price, which should in turn motivate customers to buy more product. The trade-off is a lower net income. For example, if the business selling chairs decides to have a sales promotion that discounts pricing by 25 percent, the likely result will be an increase in the volume of chairs sold.
A business with high turnover and low margin is a company that is operating efficiently, but isn't making much profit on each sale. It can afford to do this because of the number of units sold. Even though the margin on each unit is low, the number of units sold, also known as the asset turnover, is high enough to make up for the lower price. Discount retailers generally have low margins, but they make up for it in the volume of goods sold. This is one reason supply chain technology greatly improves profitability.