Fixed Assets Turnover Ratio

Formula

Fixed Assets Turnover Ratio = Sales / Net Fixed Assets

Instead of Net Fixed Assets, one can even use the Average Net Fixed Assets. The Average Net Fixed Assets is calculated by adding the Opening and Closing Net Fixed Assets for the period and dividing the result by 2.

As per the Formula the Fixed Asset Turnover Ratio needs to be calculated on Net Fixed Assets. One can always debate whether to take Gross Fixed Assets or Net Fixed Assets for the purpose of calculating Fixed Asset Turnover Ratio. It is best to calculate it on both the ways since both will give different results and thus will have different interpretations.

The 3 examples given below explain why it is better to take Gross Fixed Assets instead of Net Fixed Assets.

Examples

Various examples of Fixed Asset Turnover Ratio (FATR) to reflect the result calculated on the basis of Gross Fixed Assets vis-à-vis Net Fixed Assets are

Scenario 1

Assuming that the Turnover over a period of 5 years has remained the same and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%.

Let us Assume that Sales for each year is $ 100,000.

Fixed Assets Purchased amounts to $ 50,000

Net Fixed Assets (i.e. after Depreciation) for the 5 Years is

Year 1 – $ 42,500

Year 2 – $ 35,000

Year 3 – $ 27,500

Year 4 – $ 20,000

Year 5 – $ 12,500

Fixed Asset Turnover Ratio on Gross Fixed Assets will be

FATR = 100,000 / 50,000 = 2

Fixed Asset Turnover Ratio on Net Fixed Assets

Year 1

FATR = 100,000 / 42,500 = 2.4

Year 2

FATR = 100,000 / 35,000 = 2.9

Year 3

FATR = 100,000 / 27,500 = 3.6

Year 4

FATR = 100,000 / 20,000 = 5

Year 5

FATR = 100,000 / 12,500 = 8

Thus FATR remains the same at 2 on Gross Fixed Assets for a period of 5 years, whereas it keeps increasing year on year if calculated on Net Fixed Assets although the Sales has remained the same. It may give an indication that the company is performing well which may not necessarily be the case. In case the expenses remain the same there would also not be any difference in the profits of the company for the 5 year period.

Scenario 2

Assuming that the Turnover has increased over a period of 5 years and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%. There is additional purchase of Fixed Assets during the 5 year period.

Thus the Sales for the period of 5 years is

Year 1 – $ 100,000

Year 2 – $ 110,000

Year 3 – $ 125,000

Year 4 – $ 150,000

Year 5 – $ 200,000

Fixed Assets Purchased each year includes

Year 1 – $ 50,000

Year 2 – $ 10,000

Year 3 – Nil

Year 4 – $ 20,000

Year 5 – $ 20,000

Gross Fixed Asset Value for the period of 5 years is

Year 1 – $ 50,000

Year 2 – $ 60,000

Year 3 – $ 60,000

Year 4 – $ 80,000

Year 5 – $ 100,000

Net Fixed Asset Value for the period of 5 years is

Year 1 – $50,000 – (15% of $50,000) = $ 42,500

Year 2 – ($ 42,500 – $ 7,500) + ($10,000 – $1,500) = $ 43,500

Year 3 – ($ 35,000 – $ 7,500) + ($ 8,500 – $ 1,500) = $ 34,500

Year 4 – ($ 27,500 – $ 7,500) + ($ 7,000 – $ 1,500) + ($ 20,000 – $ 3,000) = $ 42,500

Year 5 – ($ 20,000 – $ 7,500) + ($ 5,500 – $ 1,500) + ($ 17,000 – $ 3,000) + ($ 20,000 – $ 3,000) = $ 47,500

Thus Year Wise Fixed Asset Turnover Ratio on Gross Fixed Assets and Net Fixed Assets is

Year 1

On Gross Fixed Assets

FATR = (100,000 / 50,000) = 2

On Net Fixed Assets

FATR = (100,000 / 42,500) = 2.4

Year 2

On Gross Fixed Assets

FATR = (110,000 / 60,000) = 1.8

On Net Fixed Assets

FATR = (110,000 / 43,500) = 2.5

Year 3

On Gross Fixed Assets

FATR = (125,000 / 60,000) = 2.1

On Net Fixed Assets

FATR = (125,000 / 34,500) = 3.6

Year 4

On Gross Fixed Assets

FATR = (150,000 / 80,000) = 1.9

On Net Fixed Assets

FATR = (150,000 / 42,500) = 3.5

Year 5

On Gross Fixed Assets

FATR = (200,000 / 100,000) = 2

On Net Fixed Assets

FATR = (200,000 / 47,500) = 4.2

From the example above it can be seen that FATR on Gross Fixed Assets has remained in the range of 1.8 to 2.1. Though the Turnover has doubled between Year 1 to Year 5, the company has consistently invested in Fixed Assets during these 5 years, the Gross Value of which has also doubled in these 5 years. Thus the FATR in Year 1 and Year 5 has remained the same i.e. Turnover is 2 times Gross Fixed Assets. Thus it appears that the company is capital intensive and may be heavily dependent on adding Fixed Assets to increase its turnover.

When the above ratio is calculated on the basis of Net Fixed Assets there is an improvement in FATR from 2.4 in Year 1 to 4.2 in Year 5. The FATR of 4.2 at the end of year 5 may prima facie appear to be encouraging, however this may not necessarily be the case if all facts are considered.

Calculated on Net Fixed Assets the FATR has reduced only once from Year 3 (FATR is 3.6) to Year 4 (FATR is 3.5) due to addition in Fixed Assets amounting to $ 20,000 in Year 4, whereas the Turnover has increased by only $ 25,000 between Year 3 and Year 4.

On the basis of Gross Fixed Assets, there is a good increase of FATR ratio by 0.3 between Year 2 (FATR is 1.8) to Year 3 (FATR is 2.1) since the Turnover has increased inspite of no addition in Fixed Assets.

It would be more satisfactory for an organisation to see its FATR improve due to increase in turnover rather than decrease in value of its Fixed Assets because of depreciation.

Scenario 3

Assuming that the Turnover has decreased marginally over a period of 5 years and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%.

The Sales for the period of 5 years is

Year 1 – $ 100,000

Year 2 – $ 98,000

Year 3 – $ 95,000

Year 4 – $ 90,000

Year 5 – $ 80,000

Fixed Assets Purchased amounts to $ 50,000

Net Fixed Assets (i.e. after Depreciation) for the 5 Years is

Year 1 – $ 42,500

Year 2 – $ 35,000

Year 3 – $ 27,500

Year 4 – $ 20,000

Year 5 – $ 12,500

Thus Year Wise Fixed Asset Turnover Ratio on Gross Fixed Assets and Net Fixed Assets is

Year 1

On Gross Fixed Assets

FATR = (100,000 / 50,000) = 2

On Net Fixed Assets

FATR = (100,000 / 42,500) = 2.4

Year 2

On Gross Fixed Assets

FATR = (98,000 / 50,000) = 1.96

On Net Fixed Assets

FATR = (98,000 / 35,000) = 2.8

Year 3

On Gross Fixed Assets

FATR = (95,000 / 50,000) = 1.9

On Net Fixed Assets

FATR = (95,000 / 27,500) = 3.5

Year 4

On Gross Fixed Assets

FATR = (90,000 / 50,000) = 1.8

On Net Fixed Assets

FATR = (90,000 / 20,000) = 4.5

Year 5

On Gross Fixed Assets

FATR = (80,000 / 50,000) = 1.6

On Net Fixed Assets

FATR = (80,000 / 12,500) = 6.4

From the example of Fixed Asset Turnover Ratio above again it can be seen that though the Sales is dropping every year, the FATR calculated on Net Fixed Assets has kept increasing from 2.4 (Year 1) to 6.4 (Year 5). During the same period the FATR on Gross Fixed Assets has dropped from 2 to 1.6.

There is every possibility that there is a drop in the Net Profits due to the fixed costs involved in running the business. However the FATR calculated on Net Fixed Assets will continue to show a positive picture.

Interpretation and Conclusion

A higher ratio means that the company is efficiently utilizing its Fixed Assets to generate revenue. A low ratio would mean that the company has huge funds blocked in its Fixed Assets, which may require reduction of investment in Fixed Assets or improving the sales in line with the investment. However it is also advisable to compare the ratio with companies in the same industry / business. An internal comparison on a year to year basis will not be sufficient.