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Efficiency ratios - asset turnover ratio

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It is worth understanding this ratio even though it is not a requirement of the business and management syllabus.

The asset turnover indicates how efficient the company has been in generating sales from its assets. It is sometimes said that this involves the business 'sweating their assets' - i.e. making them work harder to generate sales revenue.

A low asset turnover figure would suggest either poor trading performance (which can be evaluated by the profit margin, sales per employee figures) or an over investment in costly fixed assets. The retail sector has an average asset turnover of 1.9, with poorer performers in the sector averaging 0.8 and the better ones showing an average of 3.2.

Net assets are defined as:

Total assets (FA + CA) less current liabilities (CL)

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Some textbooks define Net Assets as Total Assets (FA + CA) less current liabilities (CL) less Long-term Liabilities (LTL) - in other words Shareholder Funds.

The ratio measures sales as units of net capital employed. The greater the numerical value of the ratio the better. A result of, say 3.5, tells you that the assets generated more than three times their value in sales for the period concerned.

A potential problem with this ratio is the valuation put on the assets; when were they last revalued? An under-valuation makes the ratio higher, and lulls the firm into thinking it is doing well. Equally, in the year when a revaluation takes place, the ratio will slump. Again, this is not a reflection on the performance of the firm. It shows that you must read accounts very carefully, especially the notes and the small print. Follow the link below for an illustration of this.

Sherston Antiques plc