Fixed Asset Turnover
It is used to assess management's ability to generate revenue from property, plant, and equipment investments.
What is Fixed Asset Turnover?
Fixed asset turnover compares net sales to net fixed assets. It assesses management's ability to generate revenue from property, plant, and equipment investments.
A high ratio indicates that the company is using its fixed assets efficiently. Work outsourcing may also be included to avoid investing in fixed assets or selling excess fixed capacity. A low asset turnover indicates a company is investing too much in fixed assets.
A low fixed asset turnover also indicates that the company needs to increase its sales to get this ratio closer to the industry average. Or the company may have made a significant investment in property, plant, and equipment with a time lag before the new asset began to generate revenue.
Another possibility was that the administrator invested in an area that did not increase the capacity of the bottleneck operation, resulting in no additional throughput.
The concept of fixed asset turnover benefits external observers who want to know how much a company uses its assets to make a sale. On the other hand, corporate insiders are less likely to use this ratio because they can access more detailed information about using certain fixed assets.
Fixed Asset Turnover Ratio Formula
The following formula is used to determine the Fixed Asset Turnover ratio:
Fixed Asset Turnover = Net Sales / Average Fixed Asset
This ratio is often used as an indicator in the manufacturing industry to make bulk purchases from PP & E to increase production.
When a company makes such a significant purchase, a knowledgeable investor will carefully monitor its ratio over the next few years to see if its new assets will reward it with higher sales.
Example of Fixed Asset Turnover Ratio
XYZ Company had annual gross sales of $400M in 2018, with sales returns and allowances of $10M. Its net fixed assets' beginning balance was $50M, while the year-end balance amounts to $60M.
Based on the given figures, the fixed asset turnover ratio for the year is 7.27, meaning that a return of almost seven dollars is earned for every dollar invested in fixed assets.
The average net fixed asset figure is calculated by summating the beginning and closing fixed assets, divided by 2.
Average Fixed Asset = (Beginning Fixed Asset + Closing Fixed Asset)/2
What Are Fixed Assets?
Tangible assets are long-term assets used to produce goods and services for more than a year.
Fixed assets, also known as property, plant, and equipment, are valuable to a company over multiple accounting periods and are depreciated over the asset's life.
Understanding assets is essential for reading the balance sheet and assessing the company's financial position.
Learning about fixed assets is an integral part of the puzzle regarding growing your business, assessing past performance, and understanding how your business works.
They are subject to regular depreciation, impairments, and disposal. These are regularly depreciated from the original asset until the end of their useful life or retirement.
Interpreting the Fixed Asset Turnover Ratio
What does a High/Low FAT indicate? Let's understand:
1. Low Ratio
A low FAT ratio indicates that the company does not use fixed assets efficiently.
Bad acquisitions are one of the reasons for the low asset turnover ratio. Therefore, acquiring companies try to find companies whose investment will help them increase their return on assets or fixed asset turnover ratio.
However, if an acquisition doesn't end up the way the acquiring company thought and generates low returns, it results in a low asset turnover ratio.
A declining ratio may also imply the company is over-investing in fixed assets.
2. High Ratio
Generally, a higher ratio is favored because it implies that the company is efficient at generating sales or revenues from its asset base.
The fact is that no such exact ratio or range determines if a company is efficient in generating sales through its investment in fixed assets.
Therefore, to analyze a company's fixed asset turnover ratio, we need to compare its ratios empirically with itself and within the industry and peer group to understand its efficiency better.
How Useful is the Fixed Asset Turnover Ratio to Investors?
Investors seeking to invest in highly capital-intensive companies can also find this helpful ratio to compare the efficiency of the investments made by a company in its fixed assets.
This assessment helps make pivotal decisions on whether to continue investing and determines how well a business is being run. It is also helpful in analyzing a company's growth to see if they are generating sales in proportion to its asset investments.
Fixed Asset Turnover Ratio vs. Asset Turnover Ratio
The asset turnover ratio uses total assets, whereas the fixed asset turnover ratio focuses only on the business's fixed assets. Total asset turnover indicates several of management's decisions regarding capital expenditures and other assets.
The asset turnover ratio includes the company's total assets, which have short & long-term assets. In addition, it accounts for the firm's long-term investment, intangibles, and current assets.
Asset Turnover Ratio= Net Sales/ Average Total Assets
Fixed Asset Turnover FAQs
A few of the ways are:
- Increasing revenue.
- Improving inventory management.
- Selling assets.
- Leasing instead of buying assets.
- Accelerating the collection of accounts receivables.
- Improving efficiency.
- Computerizing inventory and order systems.
A company investing in property, plant, and equipment is a positive sign for investors. Investment in fixed assets suggests that the company plans to increase production and they have a lot of faith in its future endeavors.
Purchases of property, plants, and equipment are a signal that management has faith in the long-term outlook and profitability of its company.
A high turnover indicates that assets are being utilized efficiently. Additionally, it could mean that the company has sold off its equipment and started outsourcing its operations.
A low asset turnover ratio compared to the industry implies that either the company has invested too much capital into fixed assets, or its sales are not enough to meet fixed asset turnover industry standards.
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