Definition, Formula, Interpretation, and Analysis of Fixed Asset Turnover Ratio
The fixed asset turnover ratio (FATR) calculates how much income a company generates for every dollar invested in non-current assets. In other words, it assesses how well management uses capital investment to generate revenue.
Fixed asset turnover ratio (FATR) that is higher or growing implies that the company is producing more income per dollar invested in fixed assets. In a nutshell, greater FATR is desirable, although it does not always mean positive in all scenarios.
Definition of Fixed Asset Turnover
The ratio of net sales to average fixed assets is known as fixed asset turnover. This ratio is one of the efficiency ratios analysts use to assess a company’s overall effective usage of its resources. It considers the ability of a company’s fixed assets to produce revenue. In other words, it reflects how well management has used fixed capital to generate increasing amounts of income.
Every business has certain fixed assets. However, because all manufacturing firms have large expenditures in fixed assets such as buildings and machines for creating the goods, manufacturing enterprises primarily utilize this ratio.
It informs investors, lenders, creditors, and management on whether the firm uses its fixed assets wisely and adequately. Whether or whether the firm has increased the efficiency of its fixed assets over time. The increase in efficiency implies that fixed assets are not sitting idle and are being used to their full potential.
The formula for Fixed Asset Turnover Ratio
The fixed asset turnover ratio is calculated using the calculation below.
Net Revenue / Net Fixed Assets = Fixed Asset Turnover Ratio
This statistic may be found in the firms’ annual reports and income statements. For this reason, the net revenue or sales after subtracting all sales returns is considered.
Gross Sales – Sales Returns = Net Revenue
Fixed Assets (Net)
This statistic is also obtained from the firms’ annual reports.
Net Fixed Assets = Gross Fixed Asset – Depreciation Accumulated
Assume a company’s annual revenues are $1.2 million. It had an average current asset of $700,000 and an average fixed asset of $1,000,000.
The fixed asset turnover ratio will be $1,200,000/$700,000 = 1.71
Total asset turnover will be $1,200,000/ ($700,000 + $1,000,000) = 0.71.
A fixed asset turnover ratio of 1.71 shows that the firm earns $1.71 for every $1 invested in fixed assets. Similarly, the firm makes $0.71 for every dollar of total assets.
- A high asset turnover ratio denotes higher efficiency.
- A low asset turnover ratio suggests inefficiency or a capital-intensive firm.
- A low fixed asset turnover ratio may also indicate that the company’s assets are brand new.
Total asset turnover ratio and working capital turnover ratio should be understood together. The fixed asset ratio is typically not constant since, even if revenue is continually increasing, the fixed assets do not follow a smooth trend. This is because the existence of current assets in the ratio might cause findings to be misinterpreted.
Relevance and Applications
- The fixed asset turnover ratio is significant from the perspective of an investor and creditor, who use it to determine how successfully a firm uses its machinery and equipment to produce revenue. This idea is essential for investors because it may calculate the estimated return on their fixed-asset investment.
- On the other hand, Creditors evaluate the ratio to determine if the firm can produce enough cash flow from the newly bought equipment to repay the loan used to purchase it. This ratio is commonly used in the manufacturing business, when corporations make significant and costly equipment acquisitions. However, top management in any firm seldom utilizes this ratio since they have insider information about sales statistics, equipment acquisitions, and other similar data that outsiders do not have. The management prefers to calculate the return on their purchases using more precise and particular data.
- If a firm has too much invested in its assets, its operational capital will be too high. Otherwise, if the firm does not spend sufficiently on its assets, it risks losing sales, which would harm its profitability, free cash flow, and, eventually, stock price. As a result, management must identify the appropriate level of investment in each of their assets.
- It is possible to compare the company’s ratio to that of other firms in the same industry and analyze how much others have invested in similar assets. Furthermore, the firm may track how much it invests in each asset each year and build a pattern to compare the year-on-year development.
Fixed assets are assets that cannot be moved. Assets and Turnover Ratio Turnover ratios are critical measures that analysts, investors, and lenders utilize. It reveals if the assets created are being used properly. A higher Fixed Asset Turnover Ratio is always seen favorably. However, the usage of ratios should be restricted to comparisons within the same industrial group.