Fixed assets turnover ratio

Fixed assets turnover ratio (also known as sales to fixed assets ratio) is a commonly used activity ratio that measures the efficiency with which a company uses its fixed assets to generate its sales revenue. It is computed by dividing net sales by average fixed assets.

Formula:

Note for students: Sometime opening balance of fixed assets may not be given in the question. In such a case, closing balance of fixed assets rather than average assets may be used as denominator of the formula.

Example:

X and Y are two independent companies that manufacture office furniture and distribute it to the sellers as well as customers in various regions of USA . The selected data for both the companies is give below:

Net sales during the year
X: $73,500
Y: $94,000

Net fixed assets at 1 January 2014:
X: $22,500
Y: $20,000

Net fixed assets at 31 December 2014
X: $24,000
Y: $21,500

 Required:

1. Calculate fixed assets turnover ratio for both the companies.
2. Can we compare the ratio of company X with that of company Y? If yes, which company is more efficient in using its fixed assets?

Solution:

(1). Calculation of fixed assets turnover ratio:

Company X:

73,500/23,250*
= 3.16

Company Y:

94,000/20,750*
= 4.53

*Average fixed assets:
X: (22,500 + 24,000)/2
Y: (20,000 + 21,500)/2

(2). Comparison of two companies:

The ratio of company X can be compared with that of company Y because both the companies belong to same industry. Generally speaking the comparability of ratios is more useful when the companies in question are in the same industry.

Company Y generates a sales revenue of $4.53 for each dollar invested in fixed assets where as company X generates a sales revenue of $3.16 for each dollar invested in fixed assets. Company Y is, therefore, more efficient than company X in using the fixed assets.

Significance and interpretation:

Generally, a high fixed assets turnover ratio indicates better utilization of fixed assets and a low ratio means inefficient or under-utilization of fixed assets. The usefulness of this ratio can be increased by comparing it with the ratio of other companies, industry standards and past years.