Fixed asset turnover is the financial ratio of revenue to total fixed assets. It shows how efficient the company utilizes its fixed assets to generate sales. A higher ratio is preferable.
Fixed asset turnover formula and its calculation
We calculate it by dividing revenue by total fixed assets. We can find the revenue figure in the income statement, while the fixed assets are on the balance sheet in the non-current assets section.
Fixed asset turnover = Revenue / Average fixed asset
Please note, the total fixed asset in the balance sheet is net, i.e., the gross fixed asset after deducted by accumulated depreciation.
Let’s calculate the fixed asset turnover ratio for PT Astra Agro Lestari Tbk (AALI).
- Year 2016 = 14,121.4 / [(16,509.6 +17,334.8) / 2] = 0.83
- Year 2017 = 17,305.7 / [(17,334.8 +17,733.1) / 2] = 0.99
- Year 2018 = 19,084.4 / [(17,733.1 + 18,135.7) / 2] = 1.06
The fixed asset turnover is important ratio because it reveals how efficiently a company generate sales from its investments in long-lived assets. We like a higher ratio because it means the company uses its fixed assets more efficiently. In contrast, a low ratio could indicate an operating inefficiency.
However, remember, no ideal ratio is considered a benchmark for all industries. Also, the ratio doesn’t tell us about the company’s ability to generate profits or cash flow.
Is a high asset turnover good?
Although a higher ratio is generally better, if the value is too high, then the company may be operating beyond its capacity. The company needs to invest in capital assets (factories, property, equipment) to support its sales or reduce overutilization.
Furthermore, a low ratio does not always mean inefficiency, but rather because of a capital-intensive business environment. Capital-intensive industries usually have a lower turnover ratio than labor-intensive industries because they heavily rely on machinery and other fixed assets in production. Therefore, the ideal ratio standard for one sector may not apply to other sectors.
For example, consider the difference between a manufacturing company and an internet service company. Manufacturing companies have much higher fixed assets than internet service companies. Thus, the manufacturing company’s fixed asset turnover ratio will be much lower than internet service companies.
New entrants yet fully operate also usually to report a low fixed asset turnover ratio. New entrants have relatively newer assets compared to incumbents. And, companies with older assets will depreciate their assets for a more extended period, allowing them to record a higher accumulation of depreciation. Thus, the book value of their fixed assets will be lower.
Why has the asset turnover ratio decreased?
A downward trend in fixed asset turnover could indicate the company is investing too much in property, plant, and equipment. When a company makes such a significant purchase, we need to monitor this ratio in the following years to see if the company’s new fixed assets contribute to increasing sales.
Some companies may also lose revenue due to decreased industry demand. Sales dropped, and many goods piled up in warehouses. As sales fall, while production is unchanged, the ratio is likely to drop.
The decline can also occur due to the effect of the sales cycle or seasonal influences, where the ratio is lower during regular periods and higher during peak periods. Therefore, to provide better insight, we should observe the same ratio for several different periods.