What is the 'Fixed-Asset Turnover Ratio'
The fixed-asset turnover ratio is, in general, used by analysts to measure operating performance. It is a ratio of net sales to fixed assets. This ratio specifically measures how able a company is to generate net sales from fixed-asset investments, namely property, plant and equipment (PP&E), net of depreciation. In a general sense, a higher fixed-asset turnover ratio indicates that a company has more effectively utilized investment in fixed assets to generate revenue.
The fixed-asset turnover ratio is calculated as:
BREAKING DOWN 'Fixed-Asset Turnover Ratio'
The fixed-asset turnover ratio is commonly used as a metric in manufacturing industries that make substantial purchases for PP&E in order to drive up output. When a company makes such significant purchases, wise investors closely monitor this ratio in subsequent years, to observe the effectiveness of such an investment in fixed assets.
In general, investments in fixed assets are representative of the sole, largest component of the company’s total assets. The ratio, calculated on an annual basis, is constructed in a way that is purposeful in reflecting how efficiently a company, primarily the company’s management team, has used these substantial assets to generate revenue for the firm.
Indications of the Fixed-Asset Turnover Ratio
While a higher ratio is indicative of greater efficiency in managing fixed-asset investments, there is not an exact number or range that dictates whether a company has been efficient at generating revenue from such investments. For this reason, it is important for analysts and investors to compare a company’s most recent ratio to both the historic ratios of the company and to ratio values from peer companies and/or industry averages.
Though the fixed-asset turnover ratio is of significant importance in certain industries, an investor or analyst must determine whether the specific company is the right type for the ratio being used, before attaching any weight to it. Fixed assets vary drastically from one company to the next. As an example, consider the difference between an Internet company and a manufacturing company. An Internet company, such as Facebook, has a significantly smaller fixed-asset base than a manufacturing giant such as Caterpillar. Clearly, in this example, Caterpillar’s fixed-asset turnover ratio is of more relevance, and should hold more weight, than that of Facebook’s.
Variations on the Ratio
Some asset-turnover ratios utilize total assets in the equation instead of fixed assets. However, the latter acts as a representative of a multiplicity of a firm’s management’s decisions on capital expenditures, because it is such a significant element in the firm’s balance sheet. A fixed-asset investment is a capital investment, but more importantly, the results of the capital investment are a greater indicator of performance, more so than that evidenced by total asset turnover.