Fixed Asset Turnover (FAT) is a sales efficiency ratio that measures how well a company utilises fixed assets to generate revenue. This ratio is computed by dividing net sales by net fixed assets over a year. The amount of property, plant, and equipment less accrued depreciation is referred to as net fixed assets.
In general, a greater fixed asset ratio indicates that fixed asset investments are being used more effectively to create revenue. This ratio is frequently examined in conjunction with leverage and profitability ratios.
What are Fixed Assets and How Do They Work?
Fixed assets are long-term or non-current assets that are employed to generate revenue in the course of company. Real estate, such as land and buildings, machinery and equipment, furniture and fittings, and cars are all examples.
They are subject to depreciation, impairments, and disposition on a regular basis. All of these are depreciated from their initial asset value on a regular basis until they are no longer functional or decommissioned.
High/low Fixed Asset Turnover Ratio Indicators:
The FAT ratio may be low if the company is underperforming in sales and has a large amount of fixed asset investment.
This is particularly true for manufacturing companies that rely on large machines and buildings. Although not all low ratios are harmful, a low FAT may have a negative connotation if the organisation recently made significant large fixed asset purchases for modernization.
A falling ratio could indicate that the corporation is over-investing in fixed assets.
Ratio is high
The majority of businesses, on the other hand, desire a high ratio. It suggests that fixed asset management is more efficient, resulting in higher returns on asset investments.
There is no precise percentage or range that can be used to establish if a corporation is effective at earning revenue from such assets. This can only be determined by comparing a company’s most recent ratio to earlier periods, as well as ratios of other similar businesses or industry norms.
Fixed assets differ substantially from one company to the next and from one industry to the next, therefore comparing ratios of similar types of organisations is important.
Is the Fixed Asset Turnover Ratio Useful to Investors?
FAT may be beneficial in evaluating and monitoring the return on money invested for investors looking for investment prospects in industries with capital-intensive businesses.
This assessment aids them in making key decisions about whether or not to continue investing, as well as determining how well a specific organisation is run. It can also be used to assess a company’s growth to check if revenues are increasing in proportion to its asset bases.
What do we make of the fixed asset turnover?
We need to know how to interpret the findings when we comprehend the fixed asset turnover ratio calculation.
The higher the fixed asset turnover ratio, we suppose, the better. This is because a high fixed asset turnover implies that a company’s fixed assets or PP&E are being used effectively and efficiently.
However, there is no single criteria that determines a strong fixed asset turnover ratio. Because different industries have different mechanics and dynamics, their good fixed asset turnover ratios are all varied. A cyclical corporation, for example, may have a low fixed asset turnover during its slow season but a high one during its busy season. As a result, the most effective way to evaluate this indicator is to compare it to the industry average.
Furthermore, a high fixed asset turnover does not always imply profitability. Despite the efficient use of fixed assets, a company may nevertheless be unprofitable due to other factors such as competition and excessive variable expenses.
Relevance and Applications
An investor or creditor will look at the fixed asset turnover ratio to see how successfully a company is utilising its machines and equipment to produce sales. This notion is crucial for investors since it allows them to calculate the estimated return on their fixed asset investment.
Creditors, on the other hand, assess the ratio to determine if the company has the ability to generate enough cash flow from newly purchased equipment to repay the loan that was used to purchase it. This ratio is frequently used in the manufacturing business, where large, expensive equipment purchases are common.
Senior management in any organisation, on the other hand, rarely use this ratio since they have insider knowledge of sales data, equipment acquisitions, and other factors that are not easily available to outsiders. Instead, the management likes to calculate the return on their investments using more specific and detailed data.
The company’s operating capital will be too high if it has too much invested in its assets. Otherwise, if the company does not put enough money into the purchase, it may lose sales, affecting profitability, free cash flow, and, finally, stock price. Management must assess the appropriate level of investment in each asset.
By comparing the company’s ratio to that of other companies in the same industry and looking at how much money others have put into similar assets. In addition, the organisation can keep track of how much they spend on each item each year and create a pattern to compare year-to-year trends.