The disclosure found in a company's footnote section of its financial statements provides useful information about the age and possible usefulness of the assets held by the company. Using the information contained in the footnote, an analyst can estimate the total age of the assets held by a company.
There are three ways to estimate the average age of a company's fixed assets:
- Average age = accumulated depreciation / current depreciation expense = X years
- Relative age = accumulated depreciation / ending gross investment = % of age
- Average depreciable life = ending gross investment / depreciation expense
Note: All these estimations are affected by what is included in fixed assets (asset mix). Relative age can be used only when the assets analyzed use a straight-line depreciation method.
Though not accurate, the estimated average age of a company's fixed assets is useful and allows an analyst to:
- Estimate if the company has old assets and will need to invest heavily in new equipment in the near future. If that is the case, the company would be currently reporting an overstated net income that is not reflective of future profitability.
- Reveal whether a company is losing its competitive advantage compared to another company that has invested heavily in new technology.
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