Tuesday, September 12, 2006

Asset Turnover

Asset Turnover is probably one of the most important ratios that Wall Street invented but ironically also the most overlooked because it's regarded as not-so-sexy and desperately needs some extreme makeover.

If Asset Turnover is so ugly then why is it important then? Well, Greenspan is ugly too in case you didn't notice. But his fart affects the lives of millions, if not billions.

Asset Turnover measures the revenue that can be generated by $1 of the firm's asset. i.e. how much money can be made from $1 of asset. It is calculated by dividing Sales over Total Assets. Do not under-estimate significance of this ratio. If only you knew its power...

Ok, so much so for the lousy parody. To increase the firm's Asset Turnover while keeping Asset constant requires operational efficiency improvement. This cannot be done if the company is slack or has a lousy management.

This ratio also has some weight partly because both its components no.s are large no.s and large no.s are not easy to manipulate. (e.g. you can make your OP increase by 50% easily by pushing back some costs, but you cannot increase your sales 50% or decrease your assets 50% overnight.)

But this also means that comparison between different companies gets tricky. You get into situations when you try to compare Asset Turnover of Firm A at 1.0614x vs that of Firm B at 1.0615x. So which is better? You can't really say for sure, unless you are a Nobel Laureate for Applied Rocket Science for Not-So-Meaningful Financial Ratio Calculation.

Hence Asset Turnover may be useful only for historical comparison. If the Asset Turnover of a company has improved from 0.9x to 1.1x, you know that it has successfully generated more sales for every dollar of asset. This no an easy feat, especially if companies are already operating at full capacity. If they can increase Asset Turnover while at full capacity, it means that they somehow can make their existing facilities work harder (by streamlining processes or making existing pool of workers work harder etc) to generate the extra revenue.

However Asset Turnover cannot be used for companies that does not generate its revenue from tangible assets. (e.g. online businesses with no assets to speak of.) In such cases, we have no choice but to return to more popular measures like ROE or OP margin

See also Fixed Asset and Depreciation
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