The sales ratio of the product or the project after all the manufacturing process of any company, may it be profit or loss whatever is the return on the invested amount is termed as the “Fixed Asset Turnover Formula”. This is also known as the comparison between the net sales profit or loss amount to the invested property, plant or the types of equipment required to manufacture that product.
The investors, shareholders, stakeholders and the creditors use this formula to know if all the equipments or the investment is being used properly for the production purpose. This is because the investors want an appropriate returns on their investments. This is particularly for the manufacturing or the production units where these companies have huge and costly equipments. Also, creditors want to sure that the company can make proper use of the types of equipment and also can make a good profit from it.
The higher the ratio, is perfectly a good example of a huge profit, as this indicates that the company has invested less amount of fixed assets for each unit of the revenue generated from the sales. If the ratio is lesser than the invested each unit of the revenue this is the loss or we can say the company has invested more fixed assets.
Generally, management doesn’t use this formula for the calculations, rather they use calculates the returns on their purchases using more detailed information.
The formula used is as below :
FAT = Net Sales / Average Fixed Assets
where, FAT = Fixed Asset Turnover
Net Sales = Gross sales
Average fixed assets = fixed assets – accumulated depreciation
If the yearly turnover is higher in the numbers this concludes that the company is utilizing the invested property, types of machinery or the types of equipment correctly. On the other hand if the turnover is low as compared to the investment made, then this concludes that the company is not utilizing the investment correctly or somewhere something is going wrong. This also indicates that the company might be manufacturing the products that clients or the customers don’t want to purchase. It can be also concluded that the company might have overestimated the demand for the products in the market.
A high or low ratio is not always responsible for the performance. There may be some other factors also which contribute to these calculations.
High depreciation can be also one of the major factors for this. It has been always calculated that the depreciated gross PPL is deducted from the net PPL.
In the same way, if the company is not replacing the types of equipment with the newer ones, these stats keep ongoing for years and the depreciation gets on increasing which in turn reduces the denominator. If the PPL is depreciated then the ration will be equal to the sales. Investors should always keep on checking the facts while the evaluation that how properly the company is using it’s invested property and equipments.
For example :
ABC and XYZ are the two different companies that manufacture furniture in India. The details for both the companies are as below :
|Net sales during the year||Rs. 73,500||Rs. 94,000|
|Net fixed assets at 1st January 2018||Rs. 22,500||Rs. 20,000|
|Net fixed assets at 31st December 2018||Rs. 24,000||Rs. 21,500|
- Fixed assets turnover ratio for both the companies
- If the ration of both the companies is compared then which company is efficient in correctly using its assets.
- We can calculate the fixed asset turnover by the formula
FAT = Net Sales / Average Fixed Assets
For company ABC,
Average fixed assets = (22500+24000)/2=23,250
∴similarly, for XYZ
Average fixed assets = (20000+21500)/2=20,750
∴ now calculating the FAT individually by using the above formula
FAT = 73500/23250 = 3.16
∴ similarly for XYZ,
FAT = 94000/20750 = 4.53
- As per the above calculations we can conclude that the ratio of company ABC is 3.16 and that of XYZ is 4.53, so the ratio of XYZ is a bit more than that of the company ABC. Hence, as per the comparison of both the companies ratio’s we can say that company XYZ is slightly more efficient than the company ABC.