Table of Contents
Fixed Asset Turnover Definition
Fixed asset turnover is ratio of net sales divided by average fixed assets. This ratio indicates how efficiently a business is using it fixed assets. It rates its operational performance relative to its investment in fixed assets. In simple words, it expresses revenue per dollar of fixed assets in the books. This metric is more useful in manufacturing industry because of the sizeable investment in the plant, property and equipments.
Fixed Asset Turnover Ratio Formula
Following equation is used to calculate fixed asset turnover ratio
Fixed Asset Turnover Ratio =Net Revenue / Average Net Fixed Assets
It denotes revenue net of returns, taxes etc.
Average Net Fixed Assets
It can be arrived with following formula:
Net Fixed Assets = Gross Fixed Assets – Accumulated Depreciation
Average Net Fixed Assets = (Opening Net Fixed Assets + Closing Net Fixed Assets) / 2
The assets are averaged out because it is quite common to buy additional fixed assets or dispose of some in a period of 1 year.
A company manufacturing tubes have fixed assets worth of $100,000 with an accumulated depreciation of $30,000. The sales of the company in the current year are $280,000.
Fixed asset turnover ratio = $280,000 / ($100,000 less $30,000) = 4.
The example above suggests that the company has achieved A ratio of 4 i.e. it has used the fixed assets 4 times.
Interpretation & Analysis
If we simply see the equation, higher the ratio better is the efficiency of the firm in utilizing the assets and vice versa.
Too high Ratio
Too high ratio indicate higher efficiency in utilization of fixed asset but This understanding may go wrong under the situation when many fixed assets are disposed off and the task of those fixed assets is Handled by outsourcing activities.
Too Low Ratio
Normally a low ratio would mean inefficient utilization of assets. In an abnormal situation like strike off, bottlenecks in production, overestimated demand, accelerated depreciation methods etc., the ratio would look Low but it can be a temporary situation and can change in the coming year. In a nutshell, before deciding anything based on the ratio it is better to analyses above mentioned circumstances also.
There is no fixed benchmark for this ratio. Still, to avail some comparison it is advisable to compare it with industry peers. Different industries have different requirement of investment in fixed assets. To get a fair idea about how a company is performing, one can compare the company’s ratios with that of the industry average ratios and the ratios same company had in past.
Other Important Points
Reinvestment in Fixed Assets
If a company does not reinvest in the fixed assets every year, this ratio is bound to rise every year because the denominator will keep reducing. It does not necessarily indicate a good sign because the company may not be raising its capacity for future growth opportunities.
Age of Fixed Assets
On similar lines, when the assets are too old and there is hardly any well you left after accumulated depreciation. This ratio will be very high or as good as the net revenues.
For an analyst, this ratio is a good indicator of efficiency but it is advisable to use it along with other financial ratios and analytics.