Measuring Asset Productivity (APR) and Utilization (AUR) Using Fixed Asset Turnover Ratio (FAT)
Businesses today are inundated with data. Efficiency as well as productivity is used for benchmarking the performance of a company and its assets. In the current dynamic environment, it is essential for companies to have a measure of how well their assets are performing, and how quickly they can expect to get value recovery on these assets through sales.
FAT and its use
The Fixed Asset Turnover Ratio (FAT) is an efficiency ratio to help companies evaluate exactly these parameters. The ratio evaluates the amount of sales that are generated against the value of the total fixed assets engaged in the underlying operation of generating those sales. This ratio is normally used in manufacturing industries where a significant portion of fixed assets are used for revenue generation. However, in recent times, the same has become a tool for measuring the output of high value service industries as well, such as hospitality, healthcare and education. Essentially, higher the asset ratio better is the utilization of the asset.
The formula for Fixed Asset Turnover Ratio = Sales / Value of Fixed Assets
Sales refers to the total sales generated by the assets in question in a fixed time period – monthly, quarterly, annually, etc.
Value of Fixed Assets refers to the value of the assets being utilized to deliver the products for sale. In case of a depreciated asset (such as capital equipment), the value is the value of the asset on the books at the time of calculation, i.e. Net Book Value or the Fair Value if asset is re-evaluated at the end of the accounting period.
The Fixed Asset Turnover Ratio is suitable for measuring the performance of companies, projects, Investment centres and Profit Centres for the assets that are part of these setups. For example, a manufacturing company would divide the usage of assets according to product lines, etc. A service provider where the fixed asset values would be relatively low (like a design firm for example) would not be able to use the Ratio effectively to measure its success.
Let’s take a look at an example to understand how the Fixed Asset Turnover Ratio works.
Mando Textiles is in the fabric production business, with a high investment in cutting=edge machine technology. The cost of the operation is therefore heavily tilted towards recovery of the machine cost.
The company is doing well and the annual sale for 2018 is USD 50 million (USD 50,000,000). The machines were bought in 2016 and have a present book value (depreciated) of USD 100 million (USD 100,000,000). The Fixed Assets Turnover ratio for the textile industry averages about 20%.
As per the above figures, the turnover ratio for the company would be 50,000,000/100,000,000 = 50%.
This signifies that going by the industry standard, the company is in good shape as the assets are performing at a level higher than industry average. If the amortization period of the machinery is 5 years, and sales are as follows:
Therefore the net returns generated by the machinery would be 115% (105% + 10% scrap value).
Older assets typically would deliver higher returns as the cost of the asset gets amortised and residual value reduces while utilization remains constant. Creating a composite of the assets used would provide an idea of the break-even point for the fixed asset investment.
Newer assets on the other hand might show lower FAT ratio, and calculating the sales required to improve the ratio would provide a target for the sales team on revenue they need to generate in order to keep the asset delivering at industry benchmarks.
This measure therefore becomes a good tool for both Finance and Planning departments as well as Board of Directors to determine the current utilization and future revenue projections required to utilize the asset profitably.
However, the Fixed Asset Turnover ratio could also be misused in some cases to show abnormally high returns, by not replacing machinery when it should be. This could have a detrimental effect on the overall sales, reflected in the number of product defects/rejects/returns. Hence, the FAT ratio should not be taken in isolation as a measure of asset performance but in conjunction with other relevant parameters such as quality of output.
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