Fixed Assets Turnover Ratio: Definition, Using, Formula and Example

Definition:

Fixed Assets Turnover is one of the efficiency ratios used to measure how efficiently of entity’s fixed assets are being used to generate sales.

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 usually used in the manufacturing industry, where most of the assets are the active fixed assets used for production and significantly affect 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 generated from the Fixed Assets that we are going to assess.

Net sales are usually 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 are not related to Sales or Sales that are not related to Fixed Assets should be excluded. It is unfair for the division to be assessed if part of the Fixed Assets is included in the list while the sale related to those assets is 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, projects, Investment centers, or Profit centers that have a large number of assets and want to evaluate those assets’ performance.

Related article  Degree Of Operating Leverage: Explanation, Formula, Example, and More

For companies or entities with small assets like service-providing companies, fixed assets turnover does not add any value to your assessment.

Example:

ABC is a manufacturing company producing clothes using labor and machine. As it operates as a high technology company, most devices are the main operation, and the works are just a tiny part.

The company’s performance 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.

Answer:

Now let’s 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 goods for these machines are included.

Based on the scenario and formula provided, 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 calculation result, the ratio is 50%, and compared to the industry average, ABC is performing exceptionally well. For a better assessment, we probably need the ratio from the competitors and the last few years to understand the trend.

We need to consider some points when interpreting the Fixed Assets Turnover ratios. As you can see, the value of fixed assets significantly affects the ratios, and what if all of the assets are old assets?

For the performance measuring that uses such ratios, intelligent management could manipulate or influence the accounting policies to ensure that he got well-performing and needed the target.

Related article  Return On Assets Analysis: Interpret, Definition, Using, and more

Finally, he will get a bonus in his pocket. Therefore, another factor should be incorporated to ensure that the ratio fairly represents the performance.

Fixed Assets Turnover in Performance Management:

Fixed Assets Turnover is a financial performance indicator that is popularly used 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, suppose the division’s performance is based on the FAT ratio. Most operation managers who do not understand accounting well could also understand, and it is straightforward for them.

This ratio is beneficial in performing the entities with high value in assets, especially when BOD wants to assess the efficiency of those assets.

The main disadvantage of Fixed Assets Turnover, mainly used as performance measurement, is that it motivates the manager to use the old assets instead of replacing them.

For example, the ratio is good, but the sales are decreasing, and most of the products are defective and returned from the customers. Using this ratio might be a danger to product quality and company reputation.