Fixed Assets Turnover Ratio
What is Fixed Assets Turnover Ratio?
Fixed Assets Turnover is one of the efficiency ratios that use to measure how efficiently the entity’s fixed assets are being used to generate sales. Just like its formula, the main idea of Fixed Assets Turnover is to assess number dollar that fixed assets could generate from sale. This ratio is normally used in the manufacturing industries where most of assets are the active fixed assets used for production and they are significantly impact the sales performance. The better ratio indicates the better performance of assets being utilize.
Formula of Fixed Assets Turnover :
The Formula of Fixed Assets Turnover Ratio is = Sales / Fixed Assets
Sales here refer to the Total Sales that generate from the Fixed Assets that we are going to assess with. For better analysis and assessment, the Fixed Assets that not related to Sales / Sales that not related to Fixed Asset should be excluding. It is unfair for the division being assess if part of the Fixed Assets are included to the list while the sale that related to those assets are not include. We use the net book value if the assets is depreciate or Fair Value if the Assets is revalue at the ended of accounting period.
Remember Fixed Assets Turnover is suitable only for assessing the companies, project, Investment Center or Profit Center that large Amount of Assets and you want to assess the performance of those assets. If the companies or entities that have small amount of assets like service providing companies, Fixed Assets Turnover is not adding any value for your assessment.
Fixed Assets Turnover: Calculation and Example
ABC is the manufacturing company and producing cloths by both using labor and machine. As it is operating the high technology company, most of the machines as the main operation and the labors are just the small part.
The performance of the company is doing well and the annual sale for 2016 is USD 50,000,000. The machines carrying value at the end of 2016 is USD 100,000,000. The Fixed Assets Turnover’ industry average is 20%.
Assess the performance of the company using Fixed Assets Turnover.
Now let do the calculation together. Assuming that USD 50,000,000 is made from the production related to the machine USD 100,000,000 and all of good for these machines are included.
Based on the scenario and formula provide about, Fixed Assets Turnover would be 50,000,000/100,000,000 = 50%.
The following is the analysis for this ratio.
Fixed Assets Turnover: Analysis and Interpretation :
As per result the calculation, the ratio is 50% and compare to the industry average, ABC is performing very well. Probably, for the better assessment, we need the ratio from the competitors as well as last few years so that we could understand the trend.
There are some points we need to consider when interpreting the Fixed Assets Turnover ratios. As you can see, the value of Fixed Assets is significantly affecting the ratios and what is all of the assets are old assets? For the performance measuring that use such kind of ratios, smart management could try to manipulate or influent over the accounting policies to ensure that he got well performing and need the target. Finally, he will get the bonus in his pocket. Therefore, another factor should be incorporate as said about to ensure that the ratio is fairly representing the performance.
Fixed Assets Turnover in Performance Management :
Well, Fixed Assets Turnover is one of the financial performance indicators that popularly use to measure the performance of the entities that I have just mention above. This ratio has many advantages and disadvantages for the entities. For example, if the performance of division is based on the FAT ratio, then most of the operation managers who do not have well understanding in accounting could also understand and it is clear for them. This ratio is very helpful in performing the entities that have high value in assets especially when BOD wants to assets the efficiency of those assets. The main disadvantage of Fixed Assets Turnover and especially when it is in use as performance measurement is it motivates manager to use the old assets and not replacing the old one.
For example, the ratio is good, but the sales are decreasing and most of the products are defect and return from the customers. Using this ratio might be danger for product quality and company reputation.
Source : http://www.wikiaccounting.com/fixed-assets-turnover-ratio/