This ratio is also known as the investment turnover ratio. It is based on the relationship between the cost of goods sold and assets/investments of a firm. A reference to this was made while working out the overall profitability of a firm as reflected in its earning power. Depending upon the different concepts of assets employed, there are many variants of this ratio.
Here, the total assets and fixed assets are net of depreciation and the assets are exclude of fictitious assets like debit balance of profit and loss account and deferred expenditures and so on.
The assets turnover ratio, howsoever defined, measures the efficiency of a firm in managing and utilizing its assets. The higher the turnover ratio, the more efficient is the management and utilization of the assets while low turnover ratios are indicative of under-utilization of available resources and presence of idle capacity. In operational terms, it implies that the firm can expand its activity level (in terms of production and sales) without requiring additional capital investments. In the case of high ratios the firm would normally be required other things being equal to make additional capital investments to operate at higher level of activity. To determine the efficiency of the ratio, it should be compared across time as well as with the industry average. In using the assets turnover ratios one point must be carefully kept in mind. The concept of assets fixed assets is net of depreciation. As a result, the ratio is likely to be higher in the case of an old and established company as compared to a new one, other things being equal. The turnover ratio is in such cases likely to give a misleading impression regarding the relative efficiency with which assets are being used. It should, therefore, be cautiously used.