Fixed asset turnover
Fixed asset turnover is an important financial ratio that helps businesses assess how effectively they use their fixed assets—such as buildings, machinery, and equipment—to generate sales. This metric is particularly valuable for evaluating the efficiency of capital-intensive sectors, such as manufacturing, where large investments in physical assets are common.
Understanding fixed asset turnover
The fixed asset turnover ratio calculates how well a company uses its fixed assets (e.g., land, buildings, hardware, equipment, etc.) to produce revenue. A higher ratio indicates that a company efficiently uses its assets to generate sales, vital for maximizing profitability and ensuring sustainable growth. Conversely, a low ratio may suggest underutilized assets or inefficiencies in asset management.
Calculating fixed asset turnover ratio
The formula below is how you can calculate the fixed asset turnover ratio for your business:
Fixed asset turnover ratio = Net sales / average fixed assets
Let's break it down a little more.
- Net sales: Represent the revenue from sales, excluding returns and discounts
- Average fixed assets: Calculated by taking the average of fixed assets at the beginning and end of the period, adjusted for depreciation
Example of fixed asset ratio
For our example, you own a small manufacturing company that reports annual net sales of $500,000. The value of their fixed assets at the beginning of the year was $400,000; at the end of the year, it was $300,000. The average fixed assets would be calculated as follows:
Average fixed assets = (400,000 + 300,000) / 2 = $350,000
The fixed asset turnover ratio would then be:
Fixed asset turnover ratio = 500,000 / 350,000 ≈ 1.43
This means that for every dollar invested in your fixed assets, you generated approximately $1.43 in sales. This result shows that your company efficiently utilized its fixed assets to generate a profit.
On the other hand, a company could underutilize its fixed assets. Let's say a bakery invested $100,000 in new kitchen equipment to expand its operations. If the bakery generates only $80,000 in sales over a year, the fixed asset turnover ratio would be 0.8. This lower ratio suggests that the bakery hasn't been able to increase its sales proportionate to its investment in fixed assets, meaning that the owners over-invested or had inefficiencies in utilizing the new equipment.
FAQs on fixed asset turnover
What is a good fixed asset turnover?
A "good" fixed asset turnover ratio varies by industry due to differences in capital intensity. Generally, a higher ratio implies more efficient use of assets. Industry benchmarks provide the best context for evaluating whether a specific ratio is good.
What if fixed asset turnover is less than one?
A fixed asset turnover ratio of less than one indicates that a company generates less sales revenue than its investment in fixed assets. This could signal inefficiencies, over-investment in assets, or underutilization.
How do you calculate the company's fixed asset turnover ratio?
To calculate the company's fixed asset turnover ratio, divide the annual net sales by the average value of fixed assets during the same period. This ratio helps measure how effectively a company uses its fixed assets to generate sales revenue.
What causes fixed asset turnover to increase?
An increase in fixed asset turnover typically results from either an increase in net sales while keeping the asset base constant or reducing the average fixed assets without a significant drop in sales. Improvements in operational efficiency, higher product demand, and better asset management strategies can all contribute to a higher fixed asset turnover.
How LegalZoom can assist
For small business owners looking to improve their asset management and overall financial health, LegalZoom offers resources that can help. Tools like LZ Books simplify financial tracking and analysis, enabling business owners to monitor key financial ratios such as fixed asset turnover. By providing easy access to your important financial data, LegalZoom can help you make informed decisions that enhance your operations and boost profitability.