Ratios: Fixed Asset Turnover - Online Tutor, Practice Problems & Exam Prep

The fixed asset turnover ratio measures a company's efficiency in using its fixed assets to generate net sales. The formula is Net⁢Sales/Average⁢Fixed⁢Assets, where average fixed assets are calculated as the sum of beginning and ending balances divided by 2. A higher ratio indicates better efficiency, with industry benchmarks varying significantly. Understanding this ratio is crucial for financial analysis and comparison within industries.

Ratios: Fixed Asset Turnover

Alright, here we go with more ratios, the fixed asset turnover ratio. So, the fixed asset turnover ratio is going to relate the amount of net sales to, guess what? Our fixed assets, right? Our average fixed assets. So, this is a measure of our efficiency. How well are we using our fixed assets?

Let's go ahead and look at our formula right here. Just like always, we are going to have a division. Our numerator has net sales divided by our average fixed assets. Remember, every time we have an average, we are going to start with our beginning balance, add the ending balance, and divide by 2. That is how we always calculate our average balance, so let me write that in here. It is always calculated as beginning balance, + ending balance 2 , okay?

And remember, if they only give you one number, they don't give you a beginning and ending balance, well, just use that number. You do not have to calculate an average. So, if they say fixed assets are $100,000, that will be your denominator.

So, how do we analyze our fixed asset turnover? Well, what does it tell us? Remember, it is how much of the numerator for each unit of the denominator. So, how many dollars of sales do we get for each dollar of fixed assets? You can imagine this is going to be different for different industries. The comparison behind me, well, you can imagine industries that have a lot of fixed assets. Again, I have used this example in other videos, the airline industry, right? They are going to have a lot of fixed assets. A bus company like Greyhound Buses, they have to have all these buses that cost a ton of money. So they are going to have a lot of fixed assets. Some businesses do not have very many fixed assets, so they are going to have different benchmarks, different amounts that would be good for this ratio.

We have to use benchmarking, right? We are going to compare it to our competitors, we are going to compare it to the industry average and see how we compare there. Generally, with all turnover, a higher ratio means that we are being more efficient with those fixed assets. If we can turn a dollar of fixed assets into $5 of sales, that is better than turning a dollar of fixed assets into $2 of sales, right? The higher the ratio, the better.

This one is not too complicated. Let's jump into some practice problems right away. Cool? Let's do it now.

XYZ Company had net sales of $500,000 and COGS of $320,000. If the beginning balance of Fixed Assets was $300,000 and the ending balance in Fixed Assets was $400,000, what is the Fixed Asset Turnover ratio?

• A. 0.51
• B. 1.25
• C. 1.43
• D. 1.67

ABC Company had $200,000 in Net Sales and Gross Profit of $80,000. If Fixed Assets equaled $400,000, what is the Fixed Asset Turnover ratio?

• A. 0.2
• B. 0.5
• C. 2.0
• D. 2.5

Here’s what students ask on this topic:

What is the fixed asset turnover ratio and how is it calculated?

The fixed asset turnover ratio measures a company's efficiency in using its fixed assets to generate net sales. The formula is:

$\frac{\mathrm{NetSales}}{\mathrm{AverageFixedAssets}}$

To calculate the average fixed assets, add the beginning and ending balances of fixed assets and divide by 2:

$\frac{\mathrm{BeginningBalance+EndingBalance}}{2}$

A higher ratio indicates better efficiency in using fixed assets to generate sales.

Why is the fixed asset turnover ratio important for financial analysis?

The fixed asset turnover ratio is crucial for financial analysis because it indicates how efficiently a company uses its fixed assets to generate sales. A higher ratio suggests that the company is effectively utilizing its fixed assets, which can lead to better profitability and competitiveness. This ratio also helps in benchmarking against industry standards and competitors, providing insights into operational efficiency and asset management.

How do you interpret the fixed asset turnover ratio in different industries?

Interpretation of the fixed asset turnover ratio varies across industries due to differences in asset intensity. For example, industries like airlines and bus companies, which require significant investment in fixed assets, typically have lower ratios compared to service-based industries with fewer fixed assets. Therefore, it's essential to compare the ratio against industry benchmarks and competitors to gauge efficiency accurately.

What are the limitations of the fixed asset turnover ratio?

While useful, the fixed asset turnover ratio has limitations. It doesn't account for the age or condition of fixed assets, which can affect efficiency. Additionally, it may not be comparable across different industries due to varying asset requirements. The ratio also doesn't consider intangible assets, which can be significant in some businesses. Therefore, it should be used alongside other financial metrics for a comprehensive analysis.

How can a company improve its fixed asset turnover ratio?

A company can improve its fixed asset turnover ratio by increasing net sales or optimizing the use of its fixed assets. Strategies include enhancing sales through better marketing, expanding product lines, or improving customer service. On the asset side, companies can invest in more efficient technology, maintain equipment properly, or sell underutilized assets to reduce the denominator in the ratio.