Fixed Asset Turnover Ratio
The Fixed Asset Turnover Ratio is a financial metric that measures a company’s ability to generate sales from its fixed assets, such as property, plant, and equipment (PP&E).
This ratio compares net sales to fixed assets and is calculated using the following formula:
\(\text{Fixed Asset Turnover Ratio} = \frac{\text{Net Sales}}{\text{Average Net Fixed Assets}} \)
Where:
- Net Sales are the gross sales minus any returns, discounts, and allowances.
- Average Net Fixed Assets is the average value of net fixed assets during the period. This can be calculated as: (Beginning Net Fixed Assets + Ending Net Fixed Assets) / 2.
A higher ratio indicates that the company is more efficient in using its fixed assets to generate sales, while a lower ratio may suggest the company has invested in too many fixed assets for the level of sales it’s achieving, or it’s not using its fixed assets efficiently.
It’s important to note that what might be considered a “good” or “bad” Fixed Asset Turnover ratio can vary significantly depending on the industry. Capital-intensive industries, such as manufacturing or utilities, may have lower ratios than industries that require less fixed asset investment, like software or services industries. Therefore, it’s most useful to compare this ratio among companies in the same industry.
Example of the Fixed Asset Turnover Ratio
Let’s say we have a manufacturing company with the following financials for the year:
- Net Sales: $2,000,000
- Net Fixed Assets at the beginning of the year: $500,000
- Net Fixed Assets at the end of the year: $600,000
First, we calculate the average net fixed assets for the year: Average Net Fixed Assets = ($500,000 + $600,000) / 2 = $550,000
Then, we use the Fixed Asset Turnover Ratio formula:
\(\text{Fixed Asset Turnover Ratio} = \frac{\text{Net Sales}}{\text{Average Net Fixed Assets}} \)
\(\text{Fixed Asset Turnover Ratio} = \frac{\$2,000,000}{\$550,000} = 3.64 \)
This means that for every dollar the company has invested in fixed assets, it generated $3.64 in sales during the year.
As previously mentioned, what constitutes a “good” fixed asset turnover ratio can vary a lot depending on the industry. Therefore, it would be useful to compare this ratio with other companies in the same industry to understand if this company is efficient in using its fixed assets to generate sales.