What is Fixed Asset Turnover Ratio?

Surely we have heard of the fixed asset turnover ratio to measure the performance of the business in investing in fixed assets to generate revenue. So fixed asset turnover what? How to calculate them?

The following article will provide all the information related to this term, please also consult with us!

What is Fixed Asset Turnover Ratio (FAT)?

Fixed Asset Turnover Ratio (FAT), abbreviated as FAT, is often analyzed, reviewed and evaluated by investors to measure a company's performance in using assets. fixed to generate revenue.

This ratio compares the net sales figures in the income statement with the fixed assets on the balance sheet and measures the ability to generate net revenue from investments in fixed assets such as factories, equipment, property, real estate (PP&E).

Fixed assets are used in the production and business process, are assets of great economic value and can be used in many production stages. Fixed asset balances are often used by businesses as an accumulated depreciation. If the fixed asset turnover ratio is high, it indicates that the company has used its fixed assets effectively in generating revenue.

What is the difference between fixed asset turnover (FAT) and total asset turnover?

The fixed asset turnover ratio (FAT) shows the ability to generate revenue from an investment in fixed assets.

Total assets of a business include all resources owned by the business, which can be short-term or long-term assets and represent the value of ownership through being converted into cash.

And total assets turnover is a financial metric used to measure the value of a business's revenue relative to its total asset value. The formula for calculating the total asset turnover ratio is as follows:

Total asset turnover = Net sales/Average total assets

In there:

Net sales (net sales): is the total revenue of the business after deducting expenses such as sales discounts, discounts, returned goods, etc.
Total average assets: is calculated as the average value of total assets at the beginning and end of the period of the enterprise.

This ratio shows how much net revenue the business will generate for each dollar invested in assets.

Many people often confuse fixed asset turnover and total asset turnover. Although both of these ratios measure and reflect the performance of a business, the asset turnover ratio considers the average total assets in the sample, while the fixed asset turnover ratio only consider the value of fixed assets because this is the type of asset that accounts for a large proportion in the business and business owners often rely on it to evaluate the effectiveness of the business model of the business.

Formula to calculate fixed asset turnover ratio (Fixed Asset Turnover Ratio)

The formula for calculating the fixed asset turnover ratio (Fixed Asset Turnover Ratio):

Fixed asset turnover = Net sales/Average total fixed assets

In there:

Net revenue (net revenue): is the total revenue earned by the enterprise after deducting such items as: sales discounts, sales discounts, sales allowances, returned goods, related expenses to taxes.
Average total fixed assets: subtract the ending balance of total fixed assets from the opening balance, then divide by 2.

This ratio shows: for each dollar of fixed assets involved in the production and business process, how much revenue the enterprise will generate, respectively.

Illustration

A business A has a total revenue of VND 200 million, of which the cost of defective products is VND 10 million. The total value of fixed assets of the enterprise is 100 million VND. Then, the fixed asset turnover ratio at that time is determined by (200 – 10) / 100 = 1.9.

Thus, with 1 million dong invested in fixed assets, enterprise A generates 1.9 million dong in revenue.

In addition, this ratio is also considered as a measure in the manufacturing industry that purchases assets such as factories, equipment, property, real estate (PP&E) to increase output. When a company makes such significant purchases, investors use the ratio to track whether new fixed assets will increase the business' sales in subsequent years.

In a nutshell, large investments in fixed assets typically represent the majority of a company's total assets. The asset turnover ratio is calculated annually to reflect whether a company knows how to effectively use its fixed assets to generate optimal revenue for the company.

Why is the fixed asset turnover ratio important in business operations?

In general, investments in fixed assets tend to represent the majority of a business's total assets. Business owners and investors will rely on the fixed asset turnover ratio to evaluate how the business uses fixed assets in generating revenue.

Especially for enterprises, factories and enterprises operating in the field of production, they will have to invest a large amount of machinery and equipment and maintain a lot of expenses for these activities.

Besides, this ratio is also very important for businesses that borrow money to invest and help them see if the business is generating enough revenue from new equipment and machinery to pay the loan. whether the business has borrowed or not.

In addition, it is equally important to compare that ratio year-over-year. This comparison shows whether the company's performance has improved for better or worse over the years.

Not only that, it is also important to compare the fixed asset turnover ratio of different companies in the industry. It helps businesses determine the company's performance compared to competitors in the industry to make appropriate strategies.

On the other hand, these indexes will help investors estimate the rate of return when deciding to invest in assets, especially for the industry that needs a lot of machinery and equipment to serve the production activities of the company. enterprise.

How good is fixed asset turnover (FAT)?

If a company has a higher fixed asset turnover ratio than other companies operating in the same industry, it shows that the company has used its fixed assets more efficiently than its competitors. competitors in generating revenue.

However, a company with low fixed asset turnover does not mean that the company is inefficient, because there are cases where the company has sold off valuable machinery and equipment and participated in real estate activities. Executing business investment strategies outside the company.

In addition, owning that low ratio also shows that the business is not using its assets to the maximum extent, this problem exists due to a number of reasons as follows:

Enterprises are currently manufacturing goods and investing in supply machinery to produce finished products, but those finished products have not really met the needs and desires of customers. This leads to the ability to spend and consume low and inefficient products and services.
Because the business overestimates the market's demand for the product
that they supply and blindly invest in machinery to do production while not having many consumers to consume.
Due to problems in the production line, production was delayed, the product quantity was not reached, resulting in lower-than-expected sales.

However, we also need to keep in mind that there is not any exact ratio or rule to judge how effectively a company is operating through its investment in assets to generate revenue. .

When considering whether the fixed asset turnover ratio is good, the enterprise often compares the most recent ratio of the enterprise with previous business periods or compares it with the ratio of rival businesses in the same period. fields.

Drawbacks of using fixed asset turnover ratio

During periods of slow growth, a company's sales may have a lower cyclical rate, so this ratio needs to be looked at over several different time periods.

In addition, the company may outsource additional units during some stages of the production process to reduce dependence on assets and improve the fixed asset turnover ratio, while still trying to maintain maintain steady cash flow and other business fundamentals.

Companies with strong asset turnover ratios can still lose money because the revenue generated from fixed assets does not maximize their ability to generate sustainable profits or good cash flow.

Conclude

Hopefully after this article, readers have a better understanding of fixed asset turnover as well as the importance of accurately assessing that ratio in a business. This is useful information that anyone who is running a business or building a business should know to have a suitable development strategy.

Information edited by Lamchutaichinh.vn