The fixed asset turnover ratio is one of the most important ratios to consider the overall uses of fixed assets by a company, which may also call return on assets and this ratio mostly used by creditors, investors and analysts.
It gives valuable knowledge about the company to investors, creditors, analysts and the company's management such as how the company uses fixed assets to improve efficiency.
What is Fixed Asset Turnover Ratio?
The fixed asset turnover ratio is an efficiency ratio that gauges how efficiently a company's management utilizes its fixed assets to generate sales. The proportion of net sales generated per rupee invested in fixed assets.
In another word, the fixed asset turnover ratio measures how well the management of a company is putting efforts to produce more sales using its fixed assets.
A higher fixed asset turnover ratio reflects the company is generating more and more sales using its net fixed assets compared to others.
Uses of Fixed Asset Turnover Ratio
The fixed asset turnover ratio is a financial ratio calculated by dividing net sales by the net fixed assets of a company. The net fixed assets contain property, plant and equipment. The fixed asset turnover measures how well a company is producing sales using its net fixed assets.
This ratio assists investors in how much profit a company generates only from fixed assets. Especially, fixed asset turnover ratio is especially useful in the manufacturing industry where companies have large and costly equipment purchases.
From a creditor point of view, this ratio measures how efficiently a company uses its newly purchased machinery to generate profit to pay back debts
What is the Fixed Asset Turnover Ratio Formula?
The fixed asset turnover ratio formula is following:
Fixed Asset Turnover Ratio = (Net Sales / Net Fixed Assets)
Net Sales
The net sales are also known as revenue. The number of net sales can be found on the income statement of the company.
Net sales are the total sales of a company minus its returns, allowances, and discounts.
Net Sales = Net sales - Allowances - Discounts
Net Fixed Assets
Few investors and analysts use average fixed assets instead of net fixed assets. The investors should be consistent with one ratio when comparing different companies within a similar sector.
The fixed assets are long term assets like lands, buildings, plants and properties etc. Fixed assets once purchased, offer benefit for a longer period.
The assets considered while calculating the fixed assets turnover should be net of accumulated depreciation.
Net Fixed Assets = Gross Fixed Asset – Accumulated Depreciation
Fixed Asset Turnover Ratio Example
It is an ABC company. Here is some information about the ABC company,
The balance sheet of ABC company as on 31.03.2019
| Non-current assets | ₹16,00,000 |
| Current assets | ₹500,000 |
| Non-current liabilities | ₹10,00,000 |
| Current liabilities | ₹400,000 |
| Share capital | ₹700,000 |
The income statement for the year ended on 31.03.2019
| Revenue | ₹20,00,000 |
| Gross profit | ₹10,00,000 |
| EBITDA | ₹100,000 |
| EBIT | ₹95,000 |
| EBT | ₹97,000 |
| Net Income | ₹95,000 |
Fixed assets turnover ratio = (2000000/1600000) = 1.25 times
The fixed asset turnover ratio of 1.25 means ABC company can generate a sale of Rs 1.25 while using fixed assets worth Rs 1.
How to interpret Fixed Asset Turnover Ratio?
The fixed asset turnover ratio tells us how effectively the company uses its plants and equipment. In the case of heavy capital, intensive sectors such as automobile, iron and steel industries will have a low fixed asset turnover ratio.
It is a useful ratio in the manufacturing industry because that industry uses a significant number of plants and machinery for its operations.
A higher asset turnover ratio indicates the efficiency of the management regarding utilization of fixed assets for increased sales and a lower amount invested in fixed assets generates more sales.
It also shows that the company has disposed of its equipment and those fixed assets are operated by outsourcing. Outsourcing will maintain a similar amount of sales and reduce the investment in fixed assets at the same time.
A lower asset turnover ratio generally reflects inefficiency in the use of the fixed assets for generating sales. In a recession or difficult situations such as overestimated the demand of their products, bottlenecks in production, when no one wants to buy the products and strike off etc this ratio will go down but normally it can be for a while and can change after some time.
There is no ideal figure to identify whether or not a company is efficiently generating sales. To judge the overall efficiency of the company and better to find out the trend of the past five years.
Hence, it is more useful when comparing companies within the same sector. Higher the fixed assets ratio is better and better is assets management of the company.
What is the difference between the fixed asset turnover ratio and the asset turnover ratio?
The asset turnover ratio focuses on the total assets of the company when the fixed asset turnover ratio only considers long term assets.
Total assets include fixed assets and short term assets. The fixed asset turnover ratio measures how well a company manages its total assets to produce more sales.
Conclusion
The fixed asset turnover ratio measures how effectively a company uses its fixed assets to produce revenue. The higher the asset turnover ratio, the better a company. It gives an insight into the company and measures the trend over a year and compares with its peers within specific sectors.
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