The sales to total assets ratio measures the ability of a business to generate sales on as small a base of assets as possible. When the ratio is quite high, it implies that management is able to wring the most possible use out of a small investment in assets.
The formula for sales to total assets is to divide net annual sales by the aggregate amount of all assets stated on an organization's balance sheet. The formula is:
(Gross sales - Sales allowances and deductions) ÷ Aggregate book value of all assets
For example, a business has annual sales of $1,000,000 after all sales allowances have been deducted, as well as receivables of $150,000, inventory of $200,000, and fixed assets of $450,000. Its sales to total assets ratio is:
$1,000,000 Net sales ÷ $800,000 Aggregate of all assets
= 1.25x Sales to total assets ratio
This ratio is not always indicative of management performance for several reasons, which are:
- The required asset base of a business varies wildly by industry. For example, an oil refinery requires a massive capital investment, while most service businesses require very little.
- The ability to generate sales does not necessarily translate into the ability to generate profits or cash flows. A company with a very high sales to total assets ratio could still lose money.
- A management team might alter operations radically just to improve this ratio, such as by outsourcing all production. This may result in a better ratio, while still damaging the fundamentals of the business.
- When sales are cyclical, the sales level may spike and drop over time, irrespective of the size of the asset investment.
The sales to total assets ratio is also known as the asset turnover ratio.