What is the Fixed Asset Turnover Ratio?
The fixed asset turnover ratio (FAT) is a powerful tool analysts use to measure operating performance. This efficiency ratio gauges how effectively a company generates net sales from its fixed-asset investments, like property, plant, and equipment (PP&E).
The fixed asset balance is calculated net of accumulated depreciation. A higher fixed asset turnover ratio usually means the company has efficiently utilized its fixed assets to generate sales.
Key Takeaways
- The fixed asset turnover ratio unveils how efficiently a company generates sales from existing fixed assets.
- It is calculated by dividing net sales by the average balance in fixed assets.
- A higher ratio suggests that management uses fixed assets more effectively.
- High FAT ratios do not necessarily indicate a company’s ability to generate solid profits or cash flows.
- The fixed asset turnover ratio focuses on specific assets, unlike the general asset turnover ratio.
Formula of the Fixed Asset Turnover Ratio
The formula for calculating the FAT ratio is:
FAT = Net Sales / Average Fixed Assets
where:
Net Sales = Gross sales, less returns and allowances
Average Fixed Assets = (NABB + Ending Balance) / 2
NABB = Net fixed assets' beginning balance
This ratio is vital for industries like manufacturing that make substantial PP&E purchases to boost output. Investors watch this ratio to see if new fixed assets translate into increased sales.
How to Interpret the Fixed Asset Turnover Ratio
Higher turnover ratios signify better efficiency in managing fixed-asset investments. Analysts compare recent ratios to historical data and peer companies’ ratios for context. FAT is particularly crucial for certain sectors; ensure the industry is suitable for this analysis.
As examples, an internet company like Meta has fewer fixed assets compared to manufacturing firms like Caterpillar, where the FAT ratio holds more weight.
Fixed Asset Turnover Ratio vs. Asset Turnover Ratio
While the fixed asset turnover ratio focuses on specific assets, the asset turnover ratio reviews the total assets. This broader ratio reflects management decisions on capital expenditures and other assets. Generally, the asset turnover ratio is smaller due to a larger denominator.
Manufacturing firms prefer the fixed asset turnover ratio to evaluate their capital investments’ performance, unlike retailers who might focus more on inventory utilization.
Pros and Cons of the Fixed Asset Turnover Ratio
Advantages:
- Highlights efficiency in using fixed assets to generate sales.
- Enables comparative analysis over time and against competitors.
Limitations:
- Companies with cyclical sales may show fluctuating ratios.
- High FAT does not guarantee profitability as it does not account for expenses or cash flow.
- Best used as a comparative, not a standalone, metric.
Example Calculation
Using Amazon’s Q3 2022 balance sheet, we find:
- Net Sales: $364.8 billion
- Average Fixed Assets: ($177.2 billion at the end of Q3 2022 + $160.3 billion at the end of 2021) / 2 = $168.75 billion
Amazon’s FAT ratio is:
FAT = $364.8 billion / $168.75 billion = 2.16
This signifies that Amazon generated $2.16 of net sales for every dollar of fixed assets it owned during this period.
What is a Good Fixed Asset Turnover Ratio?
Fixed asset turnover ratios vary by industry and size; no universal benchmark exists. Companies look at industry averages and competitors’ ratios to define a good FAT ratio, aiming to surpass both.
Should the Fixed Asset Turnover Ratio Be High or Low?
For most industries, a higher fixed asset turnover ratio is better, as it reflects greater earnings for every dollar invested in fixed assets.
Main Downside of the Fixed Asset Turnover Ratio
The FAT ratio doesn’t include company expenses. Thus, even firms with high ratios might be unprofitable due to high expenses and poor cash flow management.
The Bottom Line
The fixed asset turnover ratio is an instrumental metric for determining a company’s efficiency in using fixed assets. Calculated by dividing net sales by the average balance of fixed assets, it serves as a comparative tool over time and against peers. However, it should be used alongside other analyses to understand a company’s comprehensive performance.
Related Terms: Asset Turnover Ratio, Net Sales, Accumulated Depreciation, Capital Expenditures, PP&E.
