A fixed asset turnover ratio is the result of net sales divided by fixed assets (average). Its formula is to see that is the business using the fixed assets efficiently or not, the company is doing profit or loss. It shows the ratio of per dollar invested by profit. Commonly this formula of fixed asset turnover ratio is used in manufacturing industries. In this article, we will see how to calculate the asset turnover ratio formula. Fixed Asset Turnover is also called FAT.
The formula of fixed asset turnover ratio
FAT Ratio = Net Revenue / Average Net Fixed Assets.
Here Net Revenue means net of returns and taxes.
Average Net Fixed Assets means opening Net fixed assets + closing Net Fixed Assets / 2.
The reason average is calculated is because it is very common to but any fixed deposit in the form of real estate or equipment in a year’s time.
Example of the Formula:
If a company is manufacturing a product and it has fixed assets of $100,000 and has accumulated depreciation of $30,000 but has a sale of $280,000 then the formula will be applied as follows:
FAT ratio = 280,000 / (100,000 – 30000) = 4.:
This means that the company is giving a $4 profit in each dollar invested means 1:4.
- If the result is in High ratio
The higher ratio in the result indicated that the fixed assets are used very well. The sales very good for the company using the assets efficiently. Some times the reason for a higher ratio is that some fixed assets or types of equipment are been disposed and those tasks are done by outsourcing.
- If the results are on the lower side
If the result is on the lower side then this means that the utility of the assets is not up to the mark. The reasons could be an unexpected strike, over expected demand of the product or maybe bottlenecks. But always keep in mind that the situation could be temporary and will change in the coming months. Before taking a big decision depending on the FAT ratio you must analyze other things and see the possibilities also.
- Ideal Ratio
This is no hard and fixed rules for the ratio. Still a comparison with other companies having the same fixed assets. This will help one understand the situation better.
Some important points
What about Reinvestments in Fixed Assets
If a company is not investing in any kind of fixed assets then the ratio will rise every year. This will be because of the reduction of the denominator. But this doesn’t mean that the company will be rasing in the future coz the capacity will also be fixed.
Fixed Asset Turnover Ratio is very good for analysts and investors. But it is always advisable that this formula should be used with some other financial ratios for better results.
The fixed asset turnover ratio reveals how efficient a company is at generating sales from its existing fixed assets. A higher ratio implies that management is using its fixed assets more effectively. A high FAT ratio does not tell anything about a company’s ability to generate solid profits or cash flows.