The fixed asset turnover ratio is a metric that measures how effectively a company generates sales using their fixed assets. There's no ideal ratio that's considered a benchmark for all industries. Instead, investors should compare a company's fixed asset turnover ratio to those of other companies in the same sector. If a company has a higher fixed asset turnover ratio than its competitors, it shows the company is using its fixed assets to generate sales better than its competitors.
The fixed asset turnover ratio is calculated by dividing a company's net sales by its net property, plant, and equipment. For example, suppose an investor is comparing the fixed asset turnover ratios of companies in the manufacturing sector.
The investor is comparing companies AA, BB, and CC.
- Company AA had $2 million in net sales and net fixed assets of $500,000 for the year.
- Company BB had $1 million in net sales and net fixed assets of $600,000 for the year.
- Company CC had $5 million in net sales and net fixed assets of $2 million for the year.
The three companies have fixed asset turnover ratios of:
- AA = 4.0 or ($2,000,000 / $500,000)
- BB = 1.67 ($1,000,000 / $600,000)
- CC = 2.5 ($5,000,000 / $2,000,000)
In this particular example, company AA has the highest fixed asset turnover ratio out of the three companies, indicating it's using its fixed assets efficiently to generate sales. However, it's important to analyze why the assets of company CC, for example, are so low compared to those of its peers. Perhaps, company CC has outsourced some of its manufacturing and, as a result, has fewer fixed assets and is more efficient because of better cost controls.
The fixed assets turnover ratio can also be calculated by factoring in accumulated depreciation whereby net sales is divided by the difference between fixed assets and accumulated depreciation. However, an investor must be aware that if the fixed assets of a company are old, they will have a large amount of accumulated depreciation and will have a larger denominator, which will influence the ratio. It's important for investors to determine if the company is investing in new plant and equipment to foster growth in the years to come.
For more on assets, please read "How Are Current and Noncurrent Assets Different?"