Fixed-Asset Turnover Ratio

The fixed-asset turnover ratio is an accounting and financial ratio that is used by financial decision makers to understand the turnover frequency of a company’s fixed assets. Fixed assets of a company include property, plant, and equipment. The turnover of property, plant, and equipment can be described as the purchase and sale of property, plant, and equipment over time. The fixed-asset turnover ratio is calculated by dividing total sales by net fixed assets. Net fixed assets are defined as total fixed assets minus depreciation:

fixed asset turnover = sales / net fixed assets

To verify that the firm does not use excessive amounts of fixed assets to conduct its business, a fixed assets turnover ratio (FAT) is calculated with the following occasion:

FAT = sales / net fixed assets

This ratio is compared over several years and with other companies in the industry. Likewise, the total assets turnover ratio (TAT) should confirm the assessment of efficiency with the FAT ratio; if it doesn't, then one should look into the size of intangible assets and the level of current assets.

TAT = sales / total assets

A low ratio compared to prior years and other firms in the industry may be indicative of inefficiency (i.e., the company may have assets that are not fully utilized). A high ratio compared to industry or prior years may be indicative of excessive use of assets that may result in breakdowns.

The indirect approach to studying management's strategy pertaining to fixed assets can be much better than looking at the fixed assets amounts themselves. First in line are maintenance and repair expenses. From a production manager's point of view, such expenses must be considered mandatory. Note that because they are stated in current monetary units, they are not distorted by inflation the way fixed assets and depreciation are. Expense data is therefore reliable. If these maintenance and repair expenses increase at a faster rate than all other items of the income statement and balance sheet, or if they are much larger than in other companies of the industry, there can be some problem. The problem can be that the equipment is getting too old, and its constant repair is expensive. In such a case, management must be asked why the equipment is not replaced in a timely fashion or with better quality equipment. When clients are not served because of equipment failures, sales are lost.

If, on the contrary, maintenance and repair expense drops off in the current year, or if it is much smaller than in other companies in the industry, these conditions suggest a different problem. The company may try to save on this expense in order to boost its profit image. It should be obvious that skimping on maintenance is counterproductive: equipment will deteriorate faster in the future. However, fewer repairs can also be the result of better equipment. This is the type of inquiry that can only be answered by a physical inspection of an expert in the field. Whether maintenance and repair is too big or too small must naturally be studied in conjunction with the size of fixed assets components in the total assets of the firm, which is discussed in the next section. This relative size of fixed assets can be judged with such expenses as insurance.

 

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Chapter 10 Section C: Turnover and Efficiency from Financial Analysis by John Petroff is available under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported license. © John Petroff. UMGC has modified this work and it is available under the original license.