Fixed Assets Turnover is one of the efficiency ratios that use to measure how to efficiently of entity’s fixed assets are being used to generate sales. Just like its formula, the main idea of Fixed Assets Turnover is to assess the number of a dollar that fixed assets contribute to generating sales and revenues.
This ratio is normally used in the manufacturing industry where most of the assets are the active fixed assets used for production and they are significantly affected the sales performance.
This ratio is not applicable for use in the services provider firm. The high ratio indicates the better conversion of fixed assets on sales.
The formula of Fixed Assets Turnover:
= Total Sales Revenues / Fixed Assets
Total Sales Revenues here refer to the net sales that generate from the Fixed Assets that we are going to assess with.
Net sales are normally shown in the income statement and it is presented after the deduction of sales discount as well as sales return from gross sales.
For better analysis and assessment, the Fixed Assets that not related to Sales or Sales that not related to Fixed Assets should be excluded. It is unfair for the division being assessed if part of the Fixed Assets are included to the list while the sale that related to those assets are not included.
We use the netbook value if the assets depreciate and fair value if the Assets are revalued at the end of the accounting period.
Remember, Fixed Assets Turnover is suitable only for assessing the companies, project, Investment Center or Profit Center that a large number of assets and you want to assess the performance of those assets.
For the companies or entities that have a small number of assets like service providing companies, fixed assets turnover is not adding any value for your assessment.
ABC is the manufacturing company and producing cloths by both using labor and machine. As it is operating the high technology company, most of the machines as the main operation and the labors are just the small part.
The performance of the company is performing well and the annual sale for 2016 is USD 50,000,000. The machines carrying value at the end of 2016 is USD 100,000,000. The Fixed Assets Turnover’ industry average is 20%.
Assess the performance of the company using Fixed Assets Turnover.
Now let do the calculation together. Assuming that USD 50,000,000 is made from the production related to the machine USD 100,000,000 and all of the good for these machines are included.
Based on the scenario and formula provide about, Fixed Assets Turnover would be 50,000,000/100,000,000 = 50%.
The following is the analysis for this ratio.
Fixed Assets Turnover: Analysis and Interpretation:
As per the result of the calculation, the ratio is 50% and compare to the industry average, ABC is performing very well. Probably, for the better assessment, we need the ratio from the competitors as well as the last few years so that we could understand the trend.
There are some points we need to consider when interpreting the Fixed Assets Turnover ratios. As you can see, the value of Fixed Assets is significantly affecting the ratios and what is all of the assets are old assets?
For the performance measuring that uses such kind of ratios, smart management could try to manipulate or influence the accounting policies to ensure that he got well-performing and need the target.
Finally, he will get a bonus in his pocket. Therefore, another factor should be incorporated as said about to ensure that the ratio is fairly representing the performance.
Fixed Assets Turnover in Performance Management:
Well, Fixed Assets Turnover is one of the financial performance indicators that popularly use to measure the performance of the entities that we have just mentioned above. This ratio has many advantages and disadvantages for the entities.
For example, if the performance of division is based on the FAT ratio, then most of the operation managers who do not have a well understanding of accounting could also understand and it is clear for them.
This ratio is very helpful in performing the entities that have high value in assets especially when BOD wants to assets the efficiency of those assets.
The main disadvantage of Fixed Assets Turnover and especially when it is used as performance measurement is it motivates the manager to use the old assets and not replacing the old one.
For example, the ratio is good, but the sales are decreasing and most of the products are a defect and return from the customers. Using this ratio might be a danger for product quality and company reputation.