Fixed Asset Turnover

How efficiently a business uses fixed assets to generate sales

What is Fixed Asset Turnover?

Fixed Asset Turnover (FAT) is an efficiency ratio that indicates how well or efficiently the business uses fixed assets to generate sales. This ratio divides net sales into net fixed assets, over an annual period. The net fixed assets include the amount of property, plant, and equipment, less the accumulated depreciation. Generally, a higher fixed asset ratio implies effective utilization of investments in fixed assets to generate revenue. This ratio would be analyzed alongside leverage and profitability ratios.

Fixed Asset Turnover Ratio

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How to Calculate for the Fixed Asset Turnover Ratio?

To determine the Fixed Asset Turnover ratio, the following formula is used:

Fixed Asset Turnover = Net Sales / Average Fixed Assets

 

Example calculation

Fisher Company has annual gross sales of $10M in the year 2015, with sales returns and allowances of $10,000. Its net fixed assets’ beginning balance was $1M, while the year-end balance amounts to $1.1M. Based on the given figures, the fixed asset turnover ratio for the year is 9.51, meaning that for every one dollar invested in fixed assets, a return of almost ten dollars is earned.  The average net fixed asset is calculated by adding the beginning and ending balances, then divide that number by 2.

 

What are Fixed Assets?

Fixed assets are tangible long-term or non-current assets used in the course of business to aid in generating revenue. These include real properties, such as: land and buildings, machinery and equipment, furniture and fixtures, and vehicles. They are subject to periodic depreciation, impairments, and disposition. All of these are deducted from the initial asset value periodically until they reach the end of their usefulness or retire.

 

Indications of High / Low Fixed Asset Turnover Ratio

Low Ratio

When the business is underperforming in sales and has a relative amount of fixed assets invested, the FAT ratio may be low.

The return on fixed assets is not favorable with this low ratio due to the fact that the amount of the investment made on property and equipment is the biggest amongst the asset categories; therefore, revenue generation is reliant upon these assets.

This is especially true for manufacturing businesses that utilize big machines and facilities. Although not all low ratios are bad, if the company just made some new large purchases of fixed assets for modernization, the low FAT will have a negative connotation.

A declining ratio may also suggest that the company is over investing in its fixed assets.

High Ratio

A high ratio, on the other hand, is preferred for most businesses. It indicates that there is a greater efficiency in regards to managing fixed assets; therefore, it gives higher returns on asset investments.

There is no exact ratio or range to determine whether or not a company is efficient at generating revenue on such assets. This can only be discovered if a comparison is made between a company’s most recent ratio and previous periods and ratios of other similar businesses or industry standards.

Fixed assets vary significantly from one company to another and from one industry to another, so it is relevant to compare ratios of similar types of businesses.

 

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How Useful is Fixed Asset Turnover ratio to Investors?

Investors, who are looking for investment opportunities in an industry with capital intensive businesses, may find FAT useful in evaluating and measuring the return on the money invested.  This evaluation helps them make critical decisions on whether or not to continue investing, and it also determines how well a particular business is being run. It is likewise useful in analyzing a company’s growth to see if they are augmenting sales in proportion to their asset bases.

 

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