Fixed-Asset Turnover Ratio

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The fixed asset turnover ratio assesses the effectiveness of equipment in generating sales.
The fixed asset turnover ratio assesses the effectiveness of equipment in generating sales. (Image: Jupiterimages/Comstock/Getty Images)

The fixed asset turnover ratio is a measurement applied to a company's financial statements to help assess the efficiency and effectiveness of the business. The ratio measures the amount of sales compared to the investment in fixed assets. It is often used in machine- or equipment-heavy industries to determine whether a new investment in equipment will have a positive effect on revenues.

Where the Fixed Asset Turnover Ratio Is Used

The most relevant industries in which to use the fixed asset turnover ratio are those that have large financial investments in manufacturing equipment. Managers use the ratio to ensure that the equipment is being employed efficiently and that it is used to its useful limit. Managers can compare their company's ratio to that of competitors to see who is making the best use of their investment in machinery.

How to Calculate the Ratio

The ratio is calculated by dividing net sales into net property, plant and equipment (PPE). Net sales comes from the income statement and is defined as revenues minus returns. Net PPE is found on the balance sheet. PPE is valued at its purchase value minus any depreciation for accounting purposes. Current market value is not used at all, even though that figure may be more representative of the value of the equipment. The ratio can be calculated at any point. Some companies choose to calculate all ratios monthly and some only perform the calculations at the end of the year.

Who Looks at the Ratio

The fixed asset turnover ratio is reviewed both internally and externally. Internally, managers and the board of directors review it to ensure that they have the right balance of machinery and plant space. It is also reviewed by banks and other lenders to ensure that the fixed assets will generate enough income to pay back loans plus interest. Investors are interested in the ratio to make sure the company is investing in fixed assets appropriately and profitably.

What a Declining Ratio Means

The fixed asset turnover ratio means nothing on its own. It is relevant only when compared to the same ratio over time. The ratio should stay stable if the appropriate amount of PPE is being used in the operation. An increasing ratio means that sales are growing faster than the investment in fixed assets and are improving the bottom line. On the other hand, a declining ratio could mean one of two things: Either sales are dropping or the equipment purchases are outstripping the return they provide. If sales are dropping, management must quickly determine why so the operations can support the investment in assets. If the equipment purchases are rising quickly, it may be a problem in overspending or it may simply mean that the sales may take a while to catch up to the new equipment.

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