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What is Fixed Asset Turnover Ratio?

The fixed asset turnover ratio is an efficiency ratio that compares net sales to fixed assets to determine a company’s return on investment in fixed assets. The fixed assets include land, building, furniture, plant, and equipment. In other words, it determines how effectively a company’s machines and equipment produce sales.

This ratio is used by creditors and investors to determine how well a company’s equipment is being used to produce sales. Investors care about this notion because they want to be able to estimate a return on their investment. This is especially true in the manufacturing business, where large, expensive equipment purchases are common. Creditors want to know that a new piece of equipment will generate enough money to repay the loan that was utilized to purchase it.

What are Fixed Assets?

A fixed asset is an asset that is held with the intention of being used in the production or provision of products or services. Fixed assets are strictly not for sale in the ordinary course of business. Fixed assets are crucial in the display of financial status. They often make up a large amount of an organization’s overall assets. Furthermore, determining whether an expenditure is an asset or an expense can have a significant impact on an organization’s reported financial results. Hence, the intention of use of the asset is an important factor in classifying an asset as fixed asset or current asset. These assets could be self constructed or purchased. The examples of fixed assets are land, building, furniture, machines, goodwill, patents, copyrights, trademarks, and so on. 

What is Depreciation?

Depreciation is a measurement of a depreciable asset’s wearing out, consumption, or other loss of value due to usage, effluxion of time, or obsolescence due to technological and market developments.

It is distributed so that each accounting period charges a fair share of the depreciable amount throughout the asset’s projected useful life. Depreciation is the amortisation of assets with a predetermined useful life.

Fixed Asset Turnover Ratio Formula

Fixed Assets Turnover Ratio = Net Sales / Average Fixed Assets

Where,

Net Sales = Total Sales – Returns – Discounts

Average Fixed Assets = (Fixed Assets on The Beginning of the Period + Fixed Assets on The End of the Period) / 2

Fixed Assets = Gross Fixed Assets – Accumulated Depreciation

How to Calculate Fixed Asset Turnover Ratio?

Illustration on Calculation of Fixed Assets Turnover Ratio is:

ParticularsAmount
Fixed Assets As On 1st April 2021Rs 14,00,000
Fixed Assets As On 31st March 2022Rs 20,00,000
Accumulated Depreciation As On 1st April 2021Rs 6,00,000
Accumulated Depreciation As On 31st March 2022Rs 8,00,000
Gross SalesRs 6,00,000
ReturnsRs 20,000
DiscountsRs 40,000
Net Fixed Assets As On 1st April 2021(Gross Fixed Assets – Accumulated Depreciation)Rs 8,00,000(Rs 14,00,000 – Rs 6,00,000)
Net Fixed Assets As On 31st March 2022(Gross Fixed Assets – Accumulated Depreciation)Rs 12,00,000(Rs 20,00,000 – Rs 8,00,000)
Average Fixed Assets(Fixed Assets on The Beginning of the Period + Fixed Assets on The End of the Period) / 2Rs 10,00,000(Rs 8,00,000 + Rs 12,00,000) / 2
Net SalesTotal Sales – Returns – DiscountsRs 5,40,000(Rs 6,00,000 – Rs 20,000 – Rs 40,000)
Fixed Assets Turnover Ratio(Net Sales / Average Fixed Assets)0.54 times(Rs 5,40,000 / Rs 10,00,000)

Interpretation of Fixed Assets Turnover Ratio

Good Fixed Assets Turnover Ratio

What constitutes a good fixed asset turnover ratio is difficult to prescribe. 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. Such comparisons must be with 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 organizations is important. Hence a period on period comparison with other companies belonging to similar industries and seize is an effective measure to estimating a good ratio.

High Fixed Assets Turnover Ratio

The majority of businesses desire a high ratio. It suggests that fixed asset management is more efficient, resulting in higher returns on asset investments. A high turnover suggests that assets are being used effectively. It also suggests that a significant number of sales are being created with a small number of assets. It could also indicate that the company has begun to outsource its activities after selling off its equipment. Outsourcing would retain the same level of sales while lowering the investment in equipment.

Low Fixed Assets Turnover Ratio

A low asset turnover ratio indicates that the company isn’t getting the most out of its assets. This could be the result of a number of reasons. The 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 with large machines and facilities. Although not all low ratios are harmful. A low ratio may have a negative perception if the company recently made significant large fixed asset purchases for modernization. A falling ratio over a period could indicate that the company is over-investing in fixed assets.

Disadvantages of Using Fixed Assets Turnover Ratio

  • In a “heavy industry,” such as automobile manufacture, where a big capital expenditure is necessary to do business, the fixed asset turnover ratio is most useful. Other businesses, such as software development, have such low fixed asset investment that the ratio is useless.
  • When a company uses accelerated depreciation, such as the double declining balance method, the amount of net fixed assets in the denominator of the calculation is artificially reduced. It makes turnover appear higher than it should be.
  • Unless the company invests a comparable amount in new fixed assets to replace older ones, ongoing depreciation will diminish the quantity of the denominator. This will cause the turnover ratio to rise over time. Thus, a company whose management team chooses not to reinvest in its fixed assets will see a modest improvement in its fixed asset ratio for a period of time. After which its aged asset base will be unable to produce goods efficiently.
  • Companies with cyclical sales might have to witness a lower asset turnover ratio. This ratio would be worse for these companies during slow periods. Hence, the ratio should be examined across a period of time. Furthermore, management may be outsourcing production in order to reduce asset reliance. While improving its asset turnover ratio and trying to maintain consistent cash flows and other business fundamentals.
  • Companies with high asset turnover ratios can still lose money. The amount of revenue generated by fixed assets has no bearing on the company’s ability to generate solid profits or maintain a healthy cash flow.

What is the Asset Turnover Ratio?

The asset turnover ratio compares the company’s sales to its asset base. It assesses a company’s ability to create profit from its assets. This ratio compares a company’s gross revenue to its average total number of assets to determine how much revenue was made per rupee of assets.

Asset Turnover Ratio vs Fixed Asset Turnover Ratio

Both the asset turnover ratios measure the efficiency of a company. However, they differ in terms of their calculation, relevance, and interpretation. The asset turnover ratio measures the efficiency of an organization in using its entire asset base to generate revenue. As the name suggests, fixed asset turnover ratio is a specific measure to analyse the efficiency of using just the fixed assets to generate sales. 

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