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How to Calculate Fixed Assets Turnover Ratio?
What is Fixed Assets Turnover Ratio?
The fixed asset turnover ratio calculates a company’s ability to generate sales by using fixed asset investments. The items required to calculate fixed assets turnover are net sales which are divided by average net fixed assets. The ratio offers an insight into a company’s returns generated from the use of fixed assets, such as land, property, and machinery. In simple words, this ratio is used to judge the obtained amount of sales generated by the conversion of assets (into sales).
Formula −
The formula for Fixed Assets Turnover (FAT) is as follows −
$$\mathrm{\mathrm{FAT}\:=\:\frac{\mathrm{Net \:Sales}}{\mathrm{Average\:Net\: Fixed \:Assets}}}$$
Or
$$\mathrm{\mathrm{FAT}\:=\:\frac{\mathrm{Net \:Sales}}{\mathrm{\left ( Gross\: Fixed\: Assets\:-\:Total \:cumulative\: depreciation \right )}}}$$
Steps Used in Calculating Fixed Asset Turnover Ratio
Following steps are involved in calculating fixed asset turnover ratio −
Net Sales Item
Find the net sales item from a company’s income statement.
Calculate Average Net Fixed Assets
In the next step, calculate the average net fixed assets. For this, find out the opening and ending net fixed assets and divide it by 2. Alternately, collect the gross fixed asset and subtract accumulated depreciation from them. All of the items required in this step can be obtained from the balance sheet of the company.
Division of Net Sales
Divide net sales by average net fixed assets to get the fixed asset turnover ratio.
Example −
Suppose a company ABC has the following figures −
Sales for the year = Rs 250 Crore
Equipment it paid for = Rs 100 Crore
Depreciation of the equipment = Rs 50 Crore
$$\mathrm{\mathrm{ABC's\: fixed \:asset\: turnover\: ratio}\:=\:\frac{\mathrm{Rs\: 250\:Crore}}{\mathrm{\left (Rs \:100 \:Crore-Re 50 \:Crore\right )}}\:=\:5}$$
Therefore, ABC is generating five times of sales out of its fixed assets.
Characteristics of Fixed Asset Turnover Ratio
Following are some of the characteristics of fixed turnover ratio −
Optimum Use of Fixed Assets
A good company will have a high fixed asset turnover ratio in comparison to its competitors in the industry. The bigger the fixed asset turnover ratio, the better it is. This is so because a higher fixed asset turnover means the use of fixed assets to their optimum.
Outsourcing of Operations
A high fixed assets turnover may also mean that the company has sold its equipment and has outsourced its operations. As outsourcing would generate the same amount of sales decreasing the amount of investments required, a higher fixed assets turnover is favorable for the company.
Weak Sales or Higher Investment
A low turnover on the contrary means a weaker use of the fixed assets. This may arise for a host of factors. It may be due to weak sales or higher investment in equipment. A company that has products that are not selling well in the market will have lower fixed asset turnover too. Overestimation of production and over-investment can also be a reason for a weaker fixed assets turnover ratio. Manufacturing issues, such as bottlenecks and problematic value chains can also be the factors that lead to low fixed asset turnover.
Calculation Methods Affect Fixed Assets Turnover Ratio
In the fixed asset turnover ratio, the net profit is used by subtracting depreciation from it. So, the changes in the methods of calculation of depreciation can affect the fixed assets turnover ratio.
For example,
If double-declining depreciation is used, the book value of their equipment will go down, making the assets’ performance look better than the actual figure.
Reinvesting in Newer Equipment
If a company skips reinvesting in newer equipment with passing time, the value of the ratio will go high as the depreciation figure will go down every year. When the profit (from PPL) is correctly depreciated, the ratio will show the correct figure for the given period. So, the investors and creditors must be aware of these facts while making investments in a company.
Conclusion
It must be noted that a high or low fixed assets turnover ratio does not directly show the performance of the company. There are other factors, like most other financial ratios, that must be considered to make an informed assumption.
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