Fixed assets turnover ratio determines how efficiently a company is using it’s fixed assets to generate sales. Its also known as efficiency ratio. Before getting into the calculation part, let us first understand why fixed assets turnover ratio is required.
Business owners invest their hard earned money in to the company to get a piece of company’s earnings. Company profit is purely depended on the sales or revenue generated. Owners invested money used by management to purchase plant, property, furniture and equipment, etc. These are used to generate company’s sales from which cost of making money is deducted to find out profit.
As a fundamental analyst, you should know how effectively the company is using its fixed assets to generate sales. To know that, you need to calculate fixed assets turnover ratio or FAT. Its most effective if you are analyzing financial statements of a manufacturing concern.
Calculation of Fixed Assets turnover ratio – FAT
To calculate FAT, you need to understand what is fixed assets and gross sales of a company as its a comparison of both. Fixed assets for this calculation are tangible long-term or non-current assets such as plant, machinery, building, furniture and fixture, equipement, and vehicles used in the course of business to aid in generating revenue.
The formula for calculating FAT is to subtract accumulated depreciation from gross fixed assets and then divide the resulting figure with net annual sales.
FAT ratio = Net annual sales / (Gross fixed assets-accumulated depreciation)
Company XYZ has gross fixed assets of Rs 1,20,000 and accumulated depreciation of Rs 20000. Sales over the year is Rs 500000.
The calculation of XYZ company’s Fixed Assets Turnover ratio is:
Rs. 500000/(120000-20000) = 5
This means, company XYZ generating five times more sales than the net book value of its fixed assets.
Interpretation of FAT ratio
If the FAT is low as compared to the previous years or industry standards, then it means that investment in fixed assets of the company is too high which is not generating enough sales. In initial years of business, you may have low FAT which gradually may increase.
If the company has recently invested money in plant, machinery and other equipments for which sales will take longer time based on the industry in which it operates, then the company’s FAT ratio might be low till it generates revenue.
If fixed assets turnover ratio is very high compare to the industry standards or previous years figure, then it generally considered as better. High FAT indicates that company is effectively used and the company may invest more in plant, machineries and equipments and other fixed assets to increase its sales based on the demand of the product.
If the company manufactures most of the product by outsourcing its manufacturing operations to others or subsidiaries, then the fixed assets turnover ratio will always be high as plants, machines, equipments used for manufacturing the product will not be showing in the company’s balance sheet. Please note, investing decision should not be based on only one ratio or parameters.
For better understanding you can calculate FAT ratio of competitors and compare it with them to assess the ability of the management to use its fixed assets efficiently to generate sales. If the FAT ratio compare to its competitor is better, then it’s considered as the company is better at making money..
As a financial analyst you should not take investment decision only based on the FAT ratio. In addition to it, you must consider other financial tools to find out whether investing into it is a better choice or not.
Lenders or bankers will be interested to know the FAT ratio as they wants to make sure that the company can produce additional revenues from a new machines and plants based on its past records to pay back their loan installments that is used to fund expansion.