Total asset turnover commonly measures the liquidity of a firms total assets.
Modern financial statements provide a great deal of data on companies. Financial ratios turn that data into bits of useful information. Show
Financial ratios are generally used to:
A Few PointersFinancial ratios are most informative when used to compare companies in the same industry.
CategoriesWe can classify financial ratios into 5 categories:
Leverage RatiosThese ratios measure the firm’s long-term ability to meet its debt obligations. These are measures of overall assets relative to obligations. They include assets which are hard to sell. Examples of leverage ratios are:
Debt-to-Equity and Equity Multiplier RatiosTwo widely used leverage ratios are the debt-to-equity ratio and the equity multiplier.
To see the relationship between these two ratios, remember `Assets \equiv Liabilities + Equity`: `\text{Equity Multiplier} \equiv \frac{Assets}{Equity}` = `\frac{Debt}{Equity} + \frac{Equity}{Equity} = \text{Debt-to-Equity Ratio} + 1` Liquidity RatiosThese ratios measure the firm’s ability to meet its debt obligations over the short-term (over the next year). As an analogy, you can think of these as measuring how much money you have in your wallet. You can’t sell your house to pay your water bill this week. Examples of Liquidity Ratios are:
The Current RatioThe current ratio is widely cited. Say a firm has current assets of $10 million, and current liabilities of $8 million, then its current ratio is 1.25 times. We don’t want the current ratio to be too high (say above 2) or too low (say below 1).
Asset Use Efficiency RatiosThese measure how efficiently a firms uses its assets. For example, how much in sales does a firm generate from $1.00 in assets. Examples of asset use efficiency ratios are:
Total Asset TurnoverSay a firm has $500 million in sales, and its assets total $2 billion. Then it has a total asset turnover of 0.25 times. We interpret is as, ‘for every dollar in assets, the firm generates $0.25 in sales’.
Profitability RatiosThese measures focus on how well a firm translates a dollar of sales into income. Examples of profitability ratios are:
Profit MarginSay a firm has $100 million in net income. Alone this data point is not too useful. However, what if we also say this income was generated on $500 million in sales?
Market Value RatiosThese measures capture what value the market assigns to each dollar of a firm’s earnings, sales, or book value. Examples of market value ratios are:
Example: P/E RatioA firm’s P/E ratio is its stock price (per share) divided by its earnings per share (EPS). However, if EPS is negative the ratio is undefined.
When to Use a RatioIf you are considering buying GE’s stock. Do you care about GE’s current ratio?
Using Ratios for DuPont AnalysisThe Dupont Analysis uses ratios to show how firm efficiency and leverage can influence shareholder returns (ROE) `ROE \equiv (\text{Profit Margin})(\text{Total Asset Turnover})(\text{Equity Multiplier})`
`\frac{\text{Earnings}}{Equity} = (\frac{\text{Earnings}}{\text{Sales}})(\frac{\text{Sales}}{Assets})(\frac{Assets}{Equity})`
Interactive AppIn the next slide you can choose two stocks, and one of four financial ratios, and see their performance over time.
Credits and CollaborationClick the following links to see the code, line-by-line contributions to this presentation, and all the collaborators who have contributed to 5-Minute Finance via GitHub. What does asset turnover measure?Definition: Asset turnover ratio is the ratio between the value of a company's sales or revenues and the value of its assets. It is an indicator of the efficiency with which a company is deploying its assets to produce the revenue. Thus, asset turnover ratio can be a determinant of a company's performance.
What does total asset turnover represent quizlet?Total asset turnover measures a company's ability to use its assets to generate sales. It is defined as net sales divided by average total assets.
What is total asset turnover example?A business that has net sales of $10,000,000 and total assets of $5,000,000 has a total asset turnover ratio of 2.0. This calculation is usually performed on an annual basis.
What should total asset turnover be?In the retail sector, an asset turnover ratio of 2.5 or more could be considered good, while a company in the utilities sector is more likely to aim for an asset turnover ratio that's between 0.25 and 0.5.
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