In business, fixed asset turnover is the ratio of sales (on the Profit and loss account) to the value of fixed assets (property, plant, and equipment or PP&E, on the balance sheet). This illustrates how strong the business is using its fixed assets to achieve sales. The higher the ratio, the better, because a high ratio indicates the business has less money tied up in fixed assets for each unit of currency of sales revenue.
Fixed Asset Turnover Ratio Formula
The fixed asset formula is as follows:
|Fixed Asset Turnover = Net Sales / Average Net Fixed Assets|
Modification of the Asset Ratio
Some asset-turnover ratios utilize total assets in the equation instead of fixed assets. However, the latter acts as a representative of a multiplicity of a firm’s management’s decisions on capital expenditures, because it is such a significant element in the firm’s balance sheet. Fixed asset investment is a central investment, but more importantly, the results of the central investment are a greater indicator of performance, more so than that evidenced by total asset turnover.
Fixed Asset Turnover Ratio Calculator
A high ratio indicates that a business is:
- Doing an effective job of generating sales with a relatively small amount of fixed assets
- Third party work to avoid investing in fixed assets
- Selling off excess fixed asset capacity
A Low Ratio Indicates that a business is:
- Is over-invested in fixed assets
- Needs to issue new products to revive its sales
- Has made a large investment in fixed assets, with a time delay before the new assets start generating revenues
- Has devoted in areas that do not increase the capacity of the barrier operation, resulting in no additional throughput
The approach of the fixed asset turnover ratio is most useful to an outside observer, who wants to know how well a business is employing its assets to generate sales. A joint colleague has access to more detailed information about the usage of specific fixed assets, and so would be less inclined to employ this ratio.
Fixed Asset Ratio Example
John’s Car Rebuilding is a custom car shop that builds custom hotrods and restores old cars to their former glory. John is applying for a loan to build a new facility and expand his operations. His sales for the year are $250,000 using the equipment he paid $100,000 for. The accumulated depreciation of the equipment is $50,000.
How is the Fixed Assets Turnover Ratio Calculated?
Here’s how the bank would calculate John’s turn over.
|Fixed Asset Turnover|
As you can see, John generates five times more sales than the net book value of his assets. The bank should compare this metric with other companies similar to John’s in his industry. The metric which is 5x might be good for the architecture industry, but it might be horrible for the automotive industry that is dependent on heavy equipment.