# Asset Turnover: How to Analyze an Income Statement

The asset turnover ratio calculates the total revenue for every dollar of assets a company owns. To calculate asset turnover, take the total revenue and divide it by the average assets for the period studied. (Note: you should know how to do this. Take the beginning assets and average them with the ending assets. If XYZ had \$1 in assets in 2000 and \$10 in assets in 2001, the average asset value for the period is \$5 because \$1+\$10 divided by 2 = \$5.)

### Asset Turnover = Total Revenue ÷ Average Assets for Period

In 2000 and 2001, Alcoa (Aluminum Company of America) had \$28,355,000,000 and \$31,691,000,000 in assets respectively, meaning there were average assets of \$30,023,000,000 (\$28.355 billion + \$31.691 billion divided by 2 = \$30.023 billion). In 2001, the company generated revenue of \$22,859,000,000. When applied to the asset turnover formula, we find that Alcoa had a turn rate of .76138. That tells you that for every \$1 in assets Alcoa owned during 2001, it sold \$.76 worth of goods and services.

\$22,859,000,000 revenue ÷ \$30,023,000,000 average assets for period = .76138, or \$0.76 for every \$1 in revenue

### General Rules for Calculating Asset Turnover

There are several general rules that should be kept in mind when calculating asset turnover. First, asset turnover is meant to measure a company's efficiency in using its assets. The higher the number, the better, although investors must be sure to compare a business to its industry.

It is a fallacy to compare completely unrelated businesses as different industries have different customs, economics, characteristics, market forces and needs. The turnover for a local corner grocery store is going to be magnitudes quicker than the turnover for a manufacturer of space engine components or heavy construction equipment.

Second, the higher a company's asset turnover, the lower its profit margins tend to be (and visa versa). This is because many businesses adopt a low-margin, high-volume approach that can result in rapid growth and economies of scale. As we've previously discussed in many other articles, Wal-Mart is the quintessential example of this tactic.

Third, there may be special situations in which management purposely lowers asset turnover because it believes that a company's products are undervalued or there are other factors at play in the market that lead executives to think selling is disadvantageous at the time, so they honor past sales contracts while stockpiling incoming production. A silver mine suffering from depressed silver prices may decide not to pre-sell so much of its output, instead locking it away in a vault and then turning around to halt production if the extraction cost exceeds the sale value of each Troy ounce. This does not indicate that management is doing something wrong, though it would create a blip on the financial statements.

In the long-run, the discipline they are showing may very well result in a lot more wealth being put in the owners' collective pockets. This is one of the big reasons you cannot just look at the asset turnover ratio trajectory and come to any hard and fast conclusions; you must understand the reason behind the direction it is going and whether or not you believe it to be justifiable by the facts and conditions in place at the time.

### Alcoa Financial Statement Excerpts

 Alcoa2001 Income Statement Excerpt Period Ending Dec 31, 2001 Dec 31, 2000 Dec 31, 1999 Total Revenue \$22,859,000,000 \$23,090,000,000 \$16,447,000,000 Cost of Revenue \$17,857,000,000,000 \$17,342,000,000 \$12,536,000,000 Gross Profit \$5,002,000,000 \$5,748,000,000 \$3,911,000,000 Alcoa2001 Balance Sheet Excerpt Period Ending Dec 31, 2001 Dec 31, 2000 Dec 31, 1999 Long Term Assets Long Term Investments \$1,428,000,000 \$1,072,000,000 \$673,000,000 Property, Plant and Equipment \$11,982,000,000 \$14,323,000,000 \$9,133,000,000 Goodwill \$9,133,000,000 \$6,003,000,000 \$1,328,000,000 Intangible Assets \$674,000,000 \$821,000,000 \$117,000,000 Accumulated Amortization N/A N/A N/A Other Assets N/A N/A N/A Deferred Long Term Asset Charges \$1,746,000,000 \$1,894,000,000 \$1,015,000,000 Total Assets \$28,355,000,000 \$31,691,000,000 \$17,066,000,000