Fixed Assets Turnover Ratio: Overview, Uses, Formula, Calculation, and Limitations

Otherwise, operating inefficiencies can be created that have significant implications (i.e. long-lasting consequences) and have the potential to erode a company’s profit margins. Companies with a higher FAT ratio are often more efficient than companies with a low FAT ratio. Companies with a higher FAT ratio are generally considered to be more efficient than companies with low FAT ratio. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.

The fixed asset focuses on analyzing the effectiveness of a company in utilizing its fixed asset or PP&E, which is a non-current asset. The asset turnover ratio, on the other hand, consider total assets, which includes both current and non-current assets. No, although high fixed asset turnover means that the company utilizes its fixed assets effectively, it does not guarantee that it is profitable. A company can still have high costs that will make it unprofitable even when its operations are efficient.

Fundamental Business Principles (That Make Millions)

Net sales represent total revenue generated from the sale of goods and services, excluding discounts, returns, and allowances. For instance, comparisons between capital-intensive (“asset-heavy”) industries cannot be made with “asset-lite” industries, since their business models and reliance on long-term assets are too different. On the other hand, a value of less than 1 indicates that the assets are being used inefficiently, as in this case the asset value is higher than the income generated.

1. In contrast, the total asset version offers a broader perspective on overall asset efficiency.
2. Explore the formula, understand its significance, and discover practical examples to enhance your financial analysis skills.
3. By comparing the­se ratios across different companie­s and time periods, you can gain valuable insights and make­ more meaningful interpre­tations.
4. The­re are tools available, such as Finbox, that can help with this analysis.
5. Capital-intensive industries, such as manufacturing and telecommunications, will inherently exhibit lower asset turnover than less capital-intensive industries.

It quantifies how efficiently a company utilizes its assets to generate sales and indicates how effectively management deploys its resources. A high ratio suggests efficient asset utilization, while a low ratio may show underutilization or inefficiencies. Understanding industry norms and benchmarks helps stakeholders assess the relative efficiency of a company’s asset utilization within its specific sector. In addition, cross-industry comparisons of fixed assets turnover ratios enable investors and analysts to make more informed investment decisions and evaluate sector-specific performance metrics.

A fixed asset turnover ratio is considered good when it is 2 or higher as it indicates the company is generating more revenue per rupee of fixed assets. The ideal ratio varies by industry, so benchmarking against peers provides the most meaningful comparison for assessing performance. The fixed asset turnover ratio is a critical metric for investors conducting fundamental analysis on equities to evaluate the efficiency of a company in managing and leveraging its fixed asset base. Another important use of the ratio is to evaluate capital intensity and fixed asset utilisation over time.

Conversely, a lower ratio indicates the company is not using its assets as efficiently. Same with receivables – collections may take too long, and credit accounts may pile up. Fixed assets such as property, plant, and equipment (PP&E) could be unproductive instead of being used to their full capacity. For instance, if a manufacturing company is inefficient at generating revenue from one of its facilities, it’s unlikely that lenders and investors will feel comfortable financing expansion for a new facility. The fixed asset turnover ratio is similar to the tangible asset ratio, which does not include the net cost of intangible assets in the denominator. It is preferable to count the average fixed assets at the end of a financial year, but many calculate the net fixed assets.

What Is the Fixed Asset Turnover Ratio & How Is It Calculated?

External stakeholders and investors, on the other hand, often have only the financial statements to go by (audited or not, depending on the company). Net Sale­s Revenue re­presents the total amount of sale­s generated by the­ company, after deductions such as discounts, within a specific period. It’s, therefore, most practical, and generally most impactful, to compare FAT ratios with historical figures within an organization. Additionally, it can be useful to compare them against industry averages and with the competitors that most directly reflect a company’s size and positioning. This is ultimately the question we need, or which is most important, to answer. Simply put, the higher the turnover ratio, the more efficient a company is (at least at managing its fixed-asset investments).

A low asset turnover ratio suggests that a company might be experiencing issues with its asset management. It does not, however, necessarily imply that a company is mismanaging its assets. Some industries have asset requirements that are typically high, which could explain why the ratio is low. The asset turnover ratio is a metric that indicates the effectiveness of a company in utilising its owned resources to generate revenue or sales.

Using the example of a manufacturing company, this ratio tells you how efficiently the company is using every dollar it invests in machinery and equipment to generate revenue. This means that lenders and investors often rely on financial ratios and financial statement analysis. This allows them to perform a valuation based only on publicly available information provided by the company. Fixed asset turnover ratio is one of the ratios used to measure company performance. It’s especially helpful in capital-intensive industries like the manufacturing industry. On the other hand, a higher fixed asset turnover ratio is better for many businesses.

PPE turnover ratio, or fixed asset turnover, tells you how many dollars of sales your company receives for each dollar invested in property, plant, and equipment (PPE). In other words, this formula is used to understand how well the company is utilizing their equipment to generate sales. We monitor our fixed assets turnover to evaluate how effectively we utilize our investments in spa equipment and technology. Higher turnover rates indicate more efficient use of assets, directly correlating with increased service capacity and revenue generation.

It’s important to note that, while interesting, a high FAT ratio does not provide much insight around whether a company is actually able to generate solid profit or cash flows. That’s why it is often only one of many important financial management KPIs that successful teams are tracking today. Additionally, it could mean that the company has sold off its equipment and started to outsource its operations. Outsourcing would maintain the same amount of sales but decrease the investment in equipment at the same time.

1. The asset turnover ratio is calculated by dividing the net sales of a company by the average balance of the total assets belonging to the company.
2. It compares the dollar amount of sales to its total assets as an annualized percentage.
3. This is one of the reasons why it’s not a wise choice to solely depend on the FAT ratio to estimate profitability.
4. In particular, Capex spending patterns in recent periods must also be understood when making comparisons, as one-time periodic purchases could be misleading and skew the ratio.
5. It is impossible to determine a company’s ability to invest and utilize fixed assets to generate net sales.

How to calculate the fixed asset turnover — The fixed asset turnover ratio formula

The asset turnover ratio is also useful for comparing the utilisation of assets across different industries and businesses. The ratio’s analysis over time reveals whether asset utilisation is increasing or decreasing. Comparing the ratio to industry benchmarks facilitates the evaluation of operational efficiency in comparison to competitors. The asset turnover ratio offers valuable insights into a company’s operational efficiency in leveraging assets like inventory, property, and equipment to grow sales. It shows how efficiently you generate revenue from assets, but that on its own isn’t enough. You’ll also want to look at profitability ratios like profit margin to see how much of that revenue makes it the bottom line net income.

Final Thoughts: Mastering Efficiency Beyond the Fixed Asset Turnover Ratio

Operating ratios such as the fixed asset turnover ratio are useful for identifying trends and comparing against competitors when tracked year over year. The optimal use of facilities, machinery, and equipment to maximize sales demonstrates an efficient allocation of capital spending. The fixed asset turnover ratio is useful in determining whether a company uses its fixed assets to drive net sales efficiently. It is calculated by dividing net sales by the average balance of fixed assets of a formula of fixed asset turnover ratio period. Comparing fixed assets turnover ratio across industries provides insight into how efficiently companies in different sectors utilize their fixed assets to generate revenue.

It tells that your company utilizes fixed assets well to generate revenue, but the investments are low. It can be due to the non-availability of funds, enough depreciation of machines, and the substantial reduction of a net block. It is impossible to determine a company’s ability to invest and utilize fixed assets to generate net sales. Industries with high capital intensity, such as manufacturing or transportation, typically have higher fixed assets turnover ratios compared to service-oriented industries like consulting or healthcare. Therefore, the fixed asset turnover ratio determines if a company’s purchases of fixed assets – i.e. capital expenditures (Capex) – are being spent effectively or not.