Fixed Asset Turnover

It is used to assess management's ability to generate revenue from property, plant, and equipment investments.

Fixed asset turnover compares net sales to net fixed assets. It assesses management's ability to generate revenue from property, plant, and equipment investments.

Fixed Asset Turnover

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.

Formula For Calculating FAT

Calculation

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.

A) Calculation of the 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. 

Estimation

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

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. On the other hand, what does a High/Low FAT indicate?

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.

Ratios

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 is it Useful To The Stakeholders?

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.

Analytics

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.

Difference Between Fixed Asset Turnover Ratio and Asset Turnover            

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

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Researched and Authored by Kunal GoelLinkedin

Reviewed and Edited by Aditya Salunke I LinkedIn

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