What is Asset Turnover Ratio? Formula & Free Template

The beginning balance is the value of net fixed assets at the beginning of the balance period, whereas the ending balance is the value at the end of the period. This means that, in reality, the value of average fixed assets is equal to the value of the average net fixed assets. A high FAT ratio shows that a company is decently managing its fixed assets to generate sales. If a business is in an industry where it’s not necessary to have large physical assets investments, FAT may give the wrong impression. This is the case since the amount of the fixed asset is not that big in the first place.

Using this ratio might be a danger to product quality and company reputation. The main disadvantage of Fixed Assets Turnover, mainly used as performance measurement, is that it motivates the manager to use the old assets instead of replacing them. This ratio is beneficial in performing the entities with high value in assets, especially when BOD wants to assess the efficiency of those assets. For example, suppose the division’s performance is based on the FAT ratio. Most operation managers who do not understand accounting well could also understand, and it is straightforward for them.

  • Outsourcing would retain the same level of sales while lowering the investment in equipment.
  • Comparisons to the ratios of industry peers can gauge how a company fares against its competitors regarding its spending on long-term assets (i.e. whether it is more efficient or lagging behind peers).
  • Instead of dividing net sales by total assets, the fixed asset turnover divides net sales by only fixed assets.

Let us take Apple Inc.’s example now’s annual report for the year 2019 and illustrate the computation of the fixed asset turnover ratio. During the year, the company booked net sales of $260,174 million, while its net fixed assets at the start and end of 2019 stood at $41,304 million and $37,378 million, respectively. Calculate Apple Inc.’s fixed assets turnover ratio based on the given information. The asset turnover ratio uses total assets, whereas the fixed asset turnover ratio focuses only on the business’s fixed assets. Total asset turnover indicates several of management’s decisions regarding capital expenditures and other assets.

Example of the Fixed Asset Turnover Ratio

This ratio primarily applies to manufacturing-based companies as they have huge investments in plants, machinery, and equipment. As such, fixed assets’ utilization is critical for their business well-being. Investors and analysts can use the ratio to compare the performances of companies operating in similar industries. Fixed asset turnover (FAT) ratio financial metric measures the efficiency of a company’s use of fixed assets. This ratio assesses a company’s capacity to generate net sales from its fixed-asset investments, specifically property, plant, and equipment (PP&E).

  • Since this ratio can vary widely from one industry to the next, comparing the asset turnover ratios of a retail company and a telecommunications company would not be very productive.
  • To reiterate from earlier, the average turnover ratio varies significantly across different sectors, so it makes the most sense for only ratios of companies in the same or comparable sectors to be benchmarked.
  • It is possible that a company’s asset turnover ratio in any single year differs substantially from previous or subsequent years.
  • On the other hand, company XYZ – a competitor of ABC in the same sector – had total revenue of $8 billion at the end of the same fiscal year.

She has worked in multiple cities covering breaking news, politics, education, and more. Anjana Dhand is a Chartered Accountant who brings over 5 years of experience and a stronghold on finance and income tax. She is on a mission to stamp out unawareness and uncomplicate boring personal finance blogs to sparkle. Anjana believes in the power of education in making a smart financial decision. For example, the ratio is good, but the sales are decreasing, and most of the products are defective and returned from the customers.

Using the Asset Turnover Ratio With DuPont Analysis

But suppose the industry average ratio is 2 and a company has a ratio of 1. This would be bad because it means the company doesn’t use fixed asset balance as efficiently as its competitors. Company A’s FAT ratio is 2 ($1,000/$500), while Company B’s ratio is 0.5 ($500/$1,000). This means that Company A uses fixed assets efficiently compared to Company B. Generally speaking, the higher the ratio, the better, because a high ratio indicates the business has less money tied up in fixed assets for each unit of currency of sales revenue. A declining ratio may indicate that the business is over-invested in plant, equipment, or other fixed assets.

Companies with fewer assets on their balance sheet (e.g., software companies) tend to have higher ratios than companies with business models that require significant spending on assets. It’s important to consider other parts of financial statements when reviewing current assets. For instance, intangible assets, asset capacity, return on assets, and tangible asset ratio.

Unlike the initial equipment sale, the revenue from recurring component purchases and services provided to existing customers requires less spending on long-term assets. In particular, Capex spending patterns in recent periods must also be understood when making comparisons, as one-time periodic purchases could be misleading and skew the ratio. Below are the steps as well as the formula for calculating the asset turnover ratio. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism.

Video Explanation of Asset Turnover Ratio

When a company makes such a significant purchase, a knowledgeable investor will carefully monitor its ratio over the next few years to see if its new assets will reward it with higher sales. This ratio is often used as an indicator in the manufacturing industry to make bulk purchases from PP & E to increase production. To reiterate from earlier, the average turnover ratio varies significantly across different sectors, so it makes the most sense for only ratios of companies in the same or comparable sectors to be benchmarked. One critical consideration when evaluating the ratio is how capital-intensive the industry that the company operates in is (i.e., asset-heavy or asset-lite). But it is important to compare companies within the same industry in order to see which company is more efficient. Balancing the assets your company owns and the liabilities you incur is important to do.

How can fixed asset turnover be improved?

While the income statement measures a metric across two periods, balance sheet items reflect values at a certain point of time. The Asset Turnover Ratio is a financial metric that measures the efficiency at which a company utilizes its asset base to generate sales. A company with a higher FAT ratio may be able to generate more sales with the same amount formula of fixed asset turnover ratio of fixed assets. The fixed asset turnover ratio is similar to the tangible asset ratio, which does not include the net cost of intangible assets in the denominator. Suppose company ABC had total revenue of $10 billion at the end of its fiscal year. Its total assets were $3 billion at the beginning of the fiscal year and $5 billion at the end.

The asset turnover ratio can also be analyzed by tracking the ratio for a single company over time. As the company grows, the asset turnover ratio measures how efficiently the company is expanding over time – especially compared to the rest of the market. Although a company’s total revenue may be increasing, the asset turnover ratio can identify whether that company is becoming more or less efficient at using its assets effectively to generate profits. We can now calculate the fixed asset turnover ratio by dividing the net revenue for the year by the average fixed asset balance, which is equal to the sum of the current and prior period balance divided by two.

However, a proper analyst will first compare this result with other companies in the same industry to get a proper opinion. Furthermore, other indicators that gauge the profitability and risk of the company are also necessary to determine the performance of the business. The FAT ratio is usually calculated annually to capital-intensive businesses. Capital intensives are corporations that demand big investments in property and equipment to operate effectively. The FAT figure can tell analysts if the company’s internal management team is using its assets well. The fixed asset turnover ratio demonstrates the effectiveness of a company’s current fixed assets in driving sales.