What is the Fixed Assets Turnover Ratio?
When we talk about improvement or prediction of a company’s performance, then a lot of unique insight is needed by the leadership team.
As the leadership team has access to all kind of financial reports and data which are not shared with the outside world.
On the other hand, shareholders from outside and investors often have only the financial statements. It can be either audited or even not is depends on the company.
This led lenders and investors to often rely on the company’s financial ratios and company’s financial statement reports.
This helps them by allowing them to perform based on an assessment only on openly available information provided by the company.
One of the ratios, which is known as the capital turnover ratio, is used for measuring the company’s performance.
Especially it stands helpful in the manufacturing industry, which is also known as the capital-intensive industry.
Fairly it is way simpler to calculate the Fixed Asset Turnover ratio. Firstly, we have to deduct the accumulated depreciation from your total assets, which are on the balance sheet and arrive at the book value of the company’s assets.
Then, divide net sales, which can be found in the income statement of the company, with the company’s net asset value.
As many company assets are bought and sold around the year, investors and lenders often add the beginning balance of fixed assets and ending balance of fixed assets and later divide it by 2 to get the answer at average net fixed assets.
Understanding more about the fixed assets turnover ratio-
The efficiency of the fixed asset turnover ratio can be seen by calculations like by division of a company’s net sales by company’s net property, installed plant, and all other equipment. (Company’s property, installed plant, and equipment are considered as depreciation).
It also measures how well a company generates its sales from its property, plants, and equipment.
From an investment point of view, this ratio is helpful for the investors by which it can be seen the approximate from their return on investment, mainly in the equipment-laden manufacturing industries.
This ratio helps the creditors assess how well a piece of new machinery generates revenue for repaying the loans. The high fixed asset turnover ratio is often indicated that a company is effectively and efficiently using its assets for generating revenues.
Generally, a low fixed asset turnover ratio indicates the opposite of a higher fixed asset turnover ratio: A firm might be not using its assets effectively or not using them on its full potential for generating revenue.
To confirm the effectiveness of a company using its fixed assets, the ratios alone is not enough.
Combined with the other analysis, it can also give a visible and clear picture of operations, performance, and management of assets in the company.
What is fixed assets turnover used for?
One of the main factors which are considered is accelerated depreciation. It is necessary that we have to always use the net pay per lead by subtracting it from the depreciation from gross pay per lead.
In this case, if a company is using an accelerated depreciation method like double-declining depreciation, then artificially, the book value of their equipment will be low by making their performance look a lot better than before.
As same, if a company is not keeping reinvesting in new equipment, then this metric will particularly continue to rise over the year by year because this a rise and decline in the denominator as according to the accumulated depreciation.
If the company’s pay per lead is completely depreciated, then their ratio will be equal to their sales according to the period.
Consciousness is needed by the investors and creditors while evaluating and seeing how well the company is performing.
Formula and calculation of fixed assets turnover ratio:
The formula of Fixed assets turnover ratio-
FIXED ASSETS TURNOVER RATIO = NET SALES / FIXED ASSETS LESS ACC DEPRECIATION
Calculation of Fixed assets turnover ratio-
Divide the Net Sales with the Net Fixed Assets will be equal to X Times.
The net of accumulated depreciation should be in the equation of the denominator.
Interpretation of the calculation:
According to the industry or data from the past years for the firm, the fixed asset turnover ratio is low. Then it means that the sales are lower or the investment done in plant and equipment is too higher.
E.g., if the company has just invested, it may not be a serious problem in modernizing the fixed asset.
Generally, a higher fixed asset turnover ratio is better if the fixed asset turnover ratio is too high. In this, the business firm is possibly operating over capacity and needs to increase its asset base for supporting its sales or reduction in its capacity.
What is Good fixed assets turnover?
An indication of the efficient utilization of the company’s assets and generating a higher number of sales by using a smaller number of assets can be due to over-high assets turnover.
It can be also mean that the company is selling off its equipment’s and it has been outsourcing its operations.
As the outsourcing of sales can maintain the same amount and it can or might decrease the investment in equipment simultaneously.
On the other side, a lower turnover can indicate that the company is not completely using its assets or not using them to its fullest extent. It can also happen due to a variety of factors.
E.g., they are producing those products which no one wants to buy.
Also, there can be overestimation in demand for their product, and even it can be overinvested in those producing the products.
It might also be low due to various manufacturing problems or a blockage in the value chain held up in production during the year. It has also resulted in anticipation of fewer sales.
It should remember that a higher ratio or lower ratio does not always have a direct association with performance. There are also few factors from outside that can also be contributed to this measurement.
About High fixed asset turnover ratio-
The most preferred ratio for most businesses is the high ratio. It also indicates that the efficiency is greater in regards to managing the fixed assets. Therefore, higher returns on asset investments are received.
There is no exact ratio of ratio or range to determine whether or not a company is efficient for generating revenue on such assets. It can only be discovered if a comparison is made between a company’s most current ratio: previous periods or ratios of other than similar businesses or industry standards.
Fixed assets vary significantly change from one company to another. Also, from one industry to another, so it is relevant to compare ratios of similar businesses.
About Low fixed asset turnover ratio-
When the business is not performing in sales and has a relatively higher amount of investment in fixed assets, the Fixed Assets Turnover ratio may be lower.
Especially true for manufacturing businesses that usually utilize major types of machinery and facilities. But not all low ratios are bad; if the company is making some new large purchasing of fixed assets for modernization, then the low Fixed Assets Turnover may negatively connotation and also reduce your inventory turnover ratio.
A decline in the ratio may also suggest that the company is investing out of limits in its fixed assets.
Is higher fixed assets turnover or lower fixed assets turnover ratio better?
While calculating this ratio, you will see how many times you have generated your revenue’s fixed asset value each year.
For instance, if you have $2m in average fixed assets and have $5m in net sales for the year, then your fixed asset turnover ratio is 2.5.
Usually, a lower fixed asset turnover ratio shows that the company cannot use its assets to generate revenue.
On the other hand, a higher ratio shows greater efficiency.
Usually, a Fixed Asset Turnover Ratio can be one of the greatest ways to benchmark a particular company against another company or an average of the industry.
In this case, being “Good” or “Bad” totally depends on the industry’s standard.
Some of the industries do not lend themselves to this ratio at all. In other ways also it can be measured.
For instance, this inventory turnover ratio can stand more helpful in the retail field where the inventory is considered the major asset.
Every industry needs to be measured in different ways; it depends on how it generates revenue. For some, it is heavy on fixed assets like Property, Plant, and types of equipment, while others are depending mostly on current assets like cash, receivables, or inventory.
Different efficiency ratios track how the company is using its assets to generate its revenue. It may vary mostly by the change in the denominator of the formula to fit the asset, which is the company’s base.
It should be remembered that the fixed asset turnover is only part of the picture. It also shows how efficiently you generate revenue from the assets, but having it on its own is not enough. You cannot know everything just by generating gross sales. You will also have to look at profitability ratios like profit margin to see how much of that revenue can make it the bottom line which will improve your Debt to Income ratio.
What are the problems with the fixed assets turnover ratio?
Below points are several cautions which are regarding the use of this measurement:
It is very useful to use fixed asset turnover ratio in industries such as automobile manufacturing which is also considered in Heavy industries, where there is a requirement of large capital investment to do business.
Some other industries like software development use the fixed asset investment, which is so meager in the ratio that it is not much used.
With this ratio, a potential problem may arise if a company uses accelerated depreciation, like the double-declining balance method.
The amount of net fixed assets is artificially reduced in the denominator of the calculation, and it makes turnover appear higher in reality than it should.
Impact of re-investment-
Ongoing depreciation will be inevitable in reducing the amount of the denominator.
The turnover ratio will be rising over time unless the company is investing in an equivalent amount, then the new fixed assets need to be replaced by the older ones.
Thus, a business with a management team who are deliberately deciding not to reinvest in other fixed assets will be experiencing a gradual improvement in its fixed asset ratio in a time, after which it decrepit assets base which will be unable for the manufacture of the goods in an efficient manner.
Why are asset management ratios important?
The ratios, which are the key to analyzing how effectively your business can manage its assets to produce sales, are called the assets turnover ratio.
Asset management ratios are also called efficiency ratios or turnover ratios. Suppose you have too much invested in your company’s assets. Your operating capital will be blocked too high.
Suppose you don’t have enough money invested in Fixed assets. You will lose sales, which will hurt your profitability, free cash flow, and stock price.
As the owner of your business, you have the task of determining the right amount to invest in each of your asset accounts.
By comparing your firm with any other companies in your industry, you do that by seeing how much has been invested in asset accounts. You can also track how much you have invested in your asset accounts from year to year and see what works.
Significance and Interpretation-
Generally, a higher fixed assets turnover ratio can indicate better utilization of fixed assets, and an inefficient or under-utilization of fixed assets indicates a low ratio.
Comparing this ratio with other companies’ ratios, industry standards, and past years can stand useful.
The fixed asset turnover ratio is completely helpful for measuring how efficiently a company uses its fixed assets to generate revenue without being inherited capital intensive.
The higher the ratio is, the more efficient it is. To be truly insightful, one needs to measure the ratio trend over time or compare it against a benchmark for any specific industry.
Frequently Asked Questions-
What is a good fixed assets turnover ratio?
– The metric that measures a company’s effectiveness in generating sales using its fixed assets is the fixed asset turnover ratio. Usually, there is no ideal ratio that can be considered as a benchmark for all industries.
What do the fixed assets turnover ratio tells us?
– The ratio reveals that how efficiently a company generates sales from its existing fixed assets is the fixed assets turnover ratio. A higher ratio will imply that management is using its fixed assets more effectively. A high fixed asset turnover ratio does not tell anything about a company’s ability to generate solid profits or cash flows.
How to calculate fixed assets turnover ratio?
The fixed asset turnover ratio is an example of an efficiency ratio that will measure how well a company uses its fixed assets to generate sales.
It has been calculated by dividing net sales by the net of its property, plant, and equipment.
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