Calculate Asset Turnover Ratio

In the article “Calculate Profit Margin” and “Calculate Financial Leverage”, we showed how to calculate the profit margin from the company’s net income statement and its financial leverage from the balance sheet statement. In this article, we are going to discuss the asset turnover ratio, which is less heard from public. However, with the understanding of profit margin, financial leverage, and asset turnover ratio, we can breakdown return on equity (ROE) into these three elements and give us more insight in terms of the source of a company’s ROE. We are going to use net income and balance sheet statement from MSN Money website as an example to show you how to calculate asset turnover ratio
 

What is Asset Turnover Ratio

Asset turnover ratio is a ratio to measure business’s efficiency to generate revenue by using its asset. The higher the asset turnover ratio a company has, the more efficient a company is to generate revenue by its asset. The basic idea behind asset turnover ratio is that a company’s asset is a valuable resource. Generally a company increases its asset either from the contribution of shareholders or through the debt issuance. If a company can’t operate its asset efficiently, (e.g. generate revenue) investors might put their resources (money) to somewhere else to have better usage.
Asset Turnover Ratio = Revenue / Averaged total asset
Note we use averaged total asset during the fiscal period instead of total asset at the end of fiscal period because total asset fluctuates during the fiscal period while revenue is generated. It makes more sense to use averaged total asset to calculate the ratio
 

Calculate Asset Turnover Ratio from Net Income and Balance Sheet Statement

Because we need to know both a company’s revenue and averaged total asset in order to calculate asset turnover ratio, we need both the company’s net income and balance sheet statement in order to calculate asset turnover ratio. In the following example, we are going to use net income and balance sheet statement from company Caterpillar (CAT) to show how to calculate Caterpillar’s asset turnover ratio. You can access Caterpillar’s net income statement and balance sheet statement from MSN Money website or you can use or product, Stock Financial Statements Download, to download and export Caterpillar’s net income and balance sheet statement into .CSV format. Followings are screenshots of both downloaded net income and balance sheet statements
 

 

 

From its income statement, Caterpillar has total revenue $65875M in 2012. From its balance sheet statement, Caterpillar has averaged total asset ($81446M+$89356M)/2 = $85401M in 2012
=> Caterpillar’s asset turnover ratio in 2012 = 65875/85401 = 0.77
 

Commentary

So far we have showed you how to calculate a company’s asset turnover ratio based on its net income and balance sheet statement. Take Caterpillar for example, its asset turnover ratio is 0.77 in 2012. That means for every $1 dollar worth of asset, Caterpillar will generate $0.77 dollar revenue. However, just like profit margin, asset turnover ratio itself doesn’t give us a big picture in terms of how the company does overall. It is possible for a company to have high asset turnover ratio yet its ROE is low. In the next article, we are going to introduce DuPont formula and show you the relationship among ROE, profit margin, financial leverage, and asset turnover ratio.

Calculate Gross Margin

In the article “Calculate Profit Margin” and “Calculate Operating Margin”, we showed how to calculate the profit margin and operating margin from the company’s net income statement. In this article, we are going to discuss the gross margin and show the equation and steps how to calculate operating margin from company’s net income statement. Also we are going to explain the difference between gross margin and markup. We are going to use net income statement from MSN Money website as an example to show the calculation
 

What is Gross Margin

Similar to Profit Margin and Operating Margin, Gross Margin is also one of the ratios to measure business’s profitability. The basic idea behind gross margin is to measure how profitable for every one unit of product the business sold before accounting other expenses. For example, if you own a coffee shop and for each coffee you sold for $3. In order to make a cup of coffee, you have to purchase coffee beans, coffee machines, paper cup… with total cost $0.3 in average. That means you earn the gross profit of $2.7 for each cup of coffee you sold. From the example about, we can see the gross profit calculation doesn’t include any expenses other than cost directly related to the product itself, such as rent for space, general administration…
=>Gross Margin = Gross Profit / Revenue
Where Gross Profit = Revenue – COGS (Cost of Goods Sold)
COGS (Cost of Goods Sold) is a general term to refer to the inventory cost. From the above example, COGS would mean the cost to purchase coffee beans, paper cup…
 

Difference between Gross Margin and Markup

Many people get confused with gross margin and markup. Basically these are two methods to describe the same thing, but with different purpose. The reason why some retailers prefer gross margin and some prefer markup is because gross margin is easier to calculate the profit from the sales revenue, while markup is easier to calculate sales price from the cost. We can always derive one another from following relation relations:
Markup = Revenue / COGS -1
=> Gross Margin = Markup/ (1+Markup).
=> Markup = Gross Margin / (1-Gross Margin)
 

Calculate Gross Margin from Net Income Statement

We are going to use income statement from company Caterpillar (CAT) to show how to calculate Caterpillar’s operating margin. You can access Caterpillar’s income statement here or you can use or product, Stock Financial Statements Download, to download and export Caterpillar’s income statement.

 


 
From its income statement, Caterpillar has total operating income $18820M and total revenue $65875M in 2012. Because Gross Margin = Gross Profit / Revenue
=> Caterpillar’s gross margin in 2012 = 18820/65875 = 28.57%
Notice that gross profit ($18820M) is derived by total revenue ($65875M) – cost of revenue ($47055M). Instead of calling it COGS (cost of goods sold), MSN Money website called it cost of revenue.
 

Commentary

In the article “Calculate Profit Margin” and “Calculate Operating Margin”, we calculated Caterpillar’s profit margin and operating margin in 2012 as 8.62% and 13.01% respectively. Caterpillar’s gross margin, 28.57%, is higher than its operating margin. It is no surprise that in general a company’s gross margin > operating margin > profit margin because gross profit calculation only includes production related costs and operation profit calculation includes production related costs and other operation costs, while net profit includes all costs