Most Common Factors that Lower the Asset Turnover Ratio

Many factors contribute to a business’s success. Experts use different ratios to analyze business performance.  Asset turnover ratio is one of the most important elements used by analysts. A high asset turnover ratio shows business growth.

However, sometimes businesses might experience lower asset turnover ratios. There are a number of factors for the decrease in the asset turnover ratio. In this blog, we will explore the most common reasons for low asset turnover ratio. But first, let’s define asset turnover ratio.

What is Asset Turnover Ratio?

Asset turnover ratio is an accounting ratio used to measure the company’s revenue relative to its assets. It’s the ratio of total sales to average assets of the company. This ratio is used to measure the company’s sales efficiency.   It is calculated from time to time and compared with the previous figures. This practice allows the company to measure its sales success.

Ratio is also compared with the asset turnover ratio of other companies in the same industry. It helps evaluate the business status in the market. The asset turnover ratio also acts as an indicator of efficiency with which a company generates revenue.

How is the Asset Turnover Ratio Calculated?

For a given period of time, the asset turnover ratio of a company is determined by adding the total value of assets at the start and at the end of the period. This sum is then divided by 2. The total sales in the given period of time are then divided by the resultant number.

The formula for asset turnover ratio is: 

Asset Turnover Ratio = Total Sales ÷ ((Assets at the start of period + Assets at the end) ∕ 2)

​The higher the asset turnover, the more efficient a company is in generating revenue. Whereas lower asset turnover ratio defines the inefficiency of business sales.

Factors that Lower the Asset Turnover Ratio

Companies strive to maintain a higher asset turnover ratio. They take several steps to take it to the maximum. However, the reasons for the decrease in asset turnover ratio are as follows: 

1.  Incorrect Forecasting

One of the major reasons for the lower asset turnover ratio is inaccurate forecasting. Wrong predictions about the stocks lead to placing wrong orders. Stocking the wrong items will lead to a drop in sales. This will also lead to surplus items in the storage space and hence complicate the inventory management process.

A series of wrong purchases can have a very destructive effect on the business. It will increase company assets while decreasing sales. The asset turnover ratio will drop down to a minimum, affecting the overall business performance.

2.  High Cash Assets

Having cash assets is important for a business. However, having excessive cash assets is an inefficient practice for companies. Cash has low returns in business. Investing in the right items is necessary to increase the asset turnover ratio. Businesses with high cash assets have an asset turnover ratio between 0 and 0.1. It is important to understand market requirements and stock the right products. This will increase sales, which will in turn increase the asset turnover ratio.

3.  Dead Stock

The presence of dead stock in the inventory contributes largely towards a lower asset turnover ratio. Products that are no longer in demand are referred to as dead stock.  This stock is generated by bad purchase decisions and changes in market trends.

It is important to get rid of dead stock. Though you don’t know need to worry as there are many strategies to eliminate it. These practices help improve the asset turnover ratio.

4.  Ignoring the Customer and Market Trends

Market trends keep on changing. Customers’ inclinations to different products change from time to time. Companies that don’t follow the changing trends end up facing a decrease in sales. When a company does not consider customer requirements, it will place incorrect orders. Wrong purchases give rise to stocking unwanted items. This decreases the overall sales, which in turn decreases asset turnover ratio.

Concluding with a bonus!

Every company wants to keep its revenue and sales high. Different strategies are in practice to maintain a high asset turnover ratio. The right control over inventory data can ease the whole process up.  

An inventory management software can play   a key role here.  It provides:

  • Complete control over the inventory with real-time tracking.
  •  Accurate inventory data.
  •  Automated business processes and increases overall efficiency.

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