What does fixed asset turnover mean?
Analysts often utilize the fixed asset turnover ratio (FAT) to evaluate operational performance. This efficiency ratio shows a company’s ability to turn fixed assets like property, plant, and equipment (PP&E) into net sales. It compares net sales from the income statement to fixed assets from the balance sheet.
Netted depreciation is used to calculate the fixed asset balance. Better fixed asset turnover ratios suggest a corporation has exploited fixed asset investments to boost sales.
Fixed Asset Turnover Ratio Interpretation
A higher turnover ratio indicates better fixed-asset investment management, although no specific amount or range determines a company’s revenue generation efficiency. Analysts and investors should compare a business’s most current ratio to its historical, peer company, and industry average ratios.
The FAT ratio is essential in some businesses, but investors and analysts should ensure the firm is in the right sector or industry before relying on it.
Fixed assets vary significantly by firm type. Compare an online firm to a manufacturing company. Internet companies like Meta (previously Facebook) have fewer fixed assets than industrial giants like Caterpillar. In this case, Caterpillar’s fixed asset turnover ratio should be prioritized above Meta’s FAT ratio.
Fixed vs. Asset Turnover Ratio
The asset turnover ratio utilizes all assets, not just fixed assets like the FAT ratio. Total assets inform management choices on capital expenditures and other assets.
Your company’s asset turnover ratio will be lower than its fixed asset turnover ratio since the denominator is higher and the numerator remains the same. It also makes conceptual sense that sales and total assets differ more than sales and a subset of assets.
Manufacturing organizations choose the fixed asset turnover ratio over the asset turnover ratio to assess their capital investments effectively. Retailers with fewer fixed assets may be less concerned with FAT than inventory utilization.
It’s essential to employ the same data collection approach across periods since the fixed asset ratio is best used for comparison.
Use of Fixed Assets Ratio Limitations
Cyclical sales companies may have worse ratios in sluggish periods; therefore, check them several times. While maintaining consistent cash flows and other company fundamentals, management may outsource manufacturing to minimize asset dependency and enhance the FAT ratio.
Companies with high asset turnover rates might lose money since fixed asset sales don’t indicate profitability or cash flow. The fixed asset ratio solely considers net sales and fixed assets, not company-wide costs. Cash flow differs when net sales are received, and fixed assets are invested.
As with other financial ratios, the fixed turnover ratio is solely relevant for comparison. A corporation may best understand its performance by comparing its fixed asset ratio over time. A corporation might also learn about rivals by comparing their fixed asset ratio.
Fixed Assets Turnover Ratio Example
Amazon had $177.2 billion in property and equipment net of depreciation as of September 30, 2022, according to its Q3 2022 balance sheet. It has $160.3 billion in property and equipment as of December 31, 2021. This simplified example assumes these initial and final fixed asset balances. This example shows Amazon’s average fixed assets at $168.75 billion.
Amazon also recorded net income for these periods, as shown below. The fixed asset turnover ratio doesn’t depend on past-year sales unless we’re computing last year’s percentage. Current net sales for September 2022 are enough to calculate this year’s ratio. The total is $364.8 billion.
Amazon divides $364.8 billion of net sales by its average fixed asset balance of $168.75 to determine its fixed asset turnover ratio. Thus, the company’s static asset turnover ratio is 2.16. During this time, Amazon produced $2.16 in net sales per dollar of fixed assets.
A Good Fixed Assets Turnover Ratio?
Fixed asset turnover ratios vary by sector and organization size. Thus, all organizations have no fixed asset turnover ratio standard. Instead, organizations should compare their fixed asset turnover percentages to the industry average and their competitors. A good fixed asset turnover ratio exceeds both.
High or low fixed assets turnover ratio?
Companies with excellent fixed asset turnover rates earn more per dollar invested in fixed assets. Most want an excellent fixed asset turnover ratio.
The main drawback of the fixed assets turnover ratio
Company costs are not included in the fixed asset turnover ratio. Thus, the ratio cannot inform analysts whether a firm is profitable. A corporation with record revenues and efficient, fixed asset use may also have record variable, administrative, and other expenditures. Companies with excellent fixed asset turnover ratios may also be illiquid since they ignore cash flow.
Final Thought
The fixed asset turnover ratio shows how well a corporation uses its fixed assets to boost net sales. Net sales divided by the average fixed asset balance in a period yields the fixed asset turnover ratio. The ratio may be used to compare firms over time or against others, but it cannot detect unprofitable ones.
Conclusion
- The fixed-asset turnover ratio shows how well a corporation sells its fixed assets.
- Net sales divided by the average fixed asset balance yields a stable asset turnover ratio.
- A higher ratio indicates better stable asset management.
- A high FAT ratio doesn’t indicate a company’s profitability or cash flow.
- Similar to the asset turnover ratio, the fixed asset turnover ratio compares a company’s activities to a subset of assets.
