There are many ratios that analysts use to research companies, one of which is the total asset turnover ratio. All else being equal, a high total asset turnover ratio is better than having a low asset turnover ratio. The reasons for a low asset turnover ratio are many. However, it is important to use the total asset turnover ratio in conjunction with other ratios to get an overall picture of how a company uses its assets.
Total Asset Turnover
The total asset turnover ratio is an accounting ratio used to measure how efficient a company is in the use of its assets. The ratio is generally used to compare a company to its historical figures and to compare companies in the same industry. To calculate the total asset turnover ratio, you have to divide sales turnover by the total assets. For example, a company generated $8 million in revenue last year and it had assets of $4 million. Dividing $8 million by $4 million leads to a total asset turnover ratio of two. The total asset turnover ratios vary from industry to industry but anything close to one is considered low.
One reason for having a low total asset turnover ratio is bad acquisitions. Acquisitions are attractive if they help a company maintain or increase its returns. However, if a company makes purchases and they end up generating weak asset returns, the company will tend to have a low total asset turnover ratio. For example, a company has a turnover ratio of two but makes a series of bad acquisitions that end up being very destructive to shareholder value. The total asset turnover ratio for these acquisitions ends up being 0.5. That sends the total total asset turnover ratio for the combined company closer to one.
A company's sales vary from year to year. A company may be experiencing a decline in its business and its sales fall significantly in a year. The reasons for a decline in business could be many, such as an economic downturn or the company's competitors producing better products. This will cause it to have a low total asset turnover ratio. For example, a company had sales of $2 million two years ago, and then sales fell to $1 million last year. The assets were constant at $1 million both years. The total asset turnover ratio in this case will fall from two to one.
High Cash Balance
Having assets sit in cash is a not an efficient use of capital for a company. Cash has very low returns. A company that has cash as its only asset would generate an total asset turnover ratio of between zero and 0.1 because the interest on the balance on cash at a bank is in the single digits.
Alex Shadunsky has a bachelor's degree in finance and is pursuing a Master of Business Administration from Indiana University. He has worked at Briefing.com as a junior equity analyst specializing in health-care stocks.