Fixed Assets Turnover Ratio

Fixed assets turnover ratio is an activity ratio which measures how efficiently a company is generating revenues using its fixed assets. It calculates dollars of revenue earned per one dollar of book value of fixed assets.

Some industries are very capital-intensive while others are more labor-intensive, hence, it is important to interpret a company’s fixed assets turnover ratio in context of its industry and competitors. A high fixed asset turnover ratio is better, provided the reason for high turnover is not existence of too many fully-depreciated assets.

Formula

Fixed assets turnover ratio equals net sales divided by average fixed assets:

Fixed Assets Turnover Ratio
=Net Revenue
Average Fixed Assets

Net sales equals gross sales minus sales returns.

Average Fixed Assets

Average fixed assets balance can be calculated by dividing the sum of fixed assets carrying amounts at the start and end of the period divided by 2:

Average Fixed Assets =Opening Balance + Ending Balance
2

Interpretation

A high fixed assets turnover ratio means that the company is generating more sales and eventually earning more profit with smaller investment in fixed assets.

The most appropriate calculation of fixed assets turnover would compare net revenue with the replacement value of the fixed assets i.e. the amount that the company needs to spend right now to replace its fixed assets. In IFRS, the revaluation model makes such comparison possible but in most GAAPs (including US GAAP), accounting for fixed assets is based on the historical cost model which means that the carrying amount reflected in the financial statement is the depreciated value of the fixed assets. If most of fixed assets are fully-depreciated, total fixed assets balance will be low and the fixed asset turnover will be high, but this does not provide a complete picture of the company’s asset-utilization.

It is useful to also calculate the percentage of depreciation of the fixed assets by dividing the accumulated depreciation balance by the cost of the fixed assets. If the ratio is high, it means that the company will require significant investment in fixed assets and that the current fixed assets book value is not representative of the actual investment required in fixed assets.

Example

The following table outlines information required to calculate fixed assets turnover for Facebook, Inc. (NYSE: FB), LinkedIn Corporation (NYSE: LNKD) and Wal-Mart Stores Inc. (NYSE: WMT). All amounts are in million dollars.

FBLNKDWMT
Net revenue5,089972469,162
Fixed asset at the start of most recent year1,475115112,324
Fixed asset at the end of the most recent year2,391187116,681

Calculate and interpret their fixed assets turnover ratio.

Solution

Fixed assets turnover ratio of FB = 5,089 = 2.63
(1,475 + 2,391) ÷ 2
Fixed assets turnover ratio of LNKD = 972 = 6.44
(115 + 187) ÷ 2
Fixed assets turnover of WMT = 469,162 = 4.06
(112,324 + 116,681) ÷ 2

The analysis shows that LinkedIn Corporation has most efficiently used its fixed assets. It generated $6.44 of revenue per $1 dollar of its net fixed assets over the year. Facebook, Inc. on the other hand, has a fixed asset turnover ratio of 2.63, which means $2.63 of revenue per $1 of investment in fixed assets. LinkedIn and Facebook are competitors with the same age; hence the comparison using fixed asset turnover ratio is relevant. LinkedIn is the clear winner on this parameter.

Comparison between Facebook and Wal-Mart on fixed asset turnover ratio might not be useful because they belong to different industries and they have different age. Wal-Mart's higher fixed asset turnover ratio might be due to old age (and hence lower book value) of Wal-Mart's assets. Lower book value of fixed assets means smaller denominator in the ratio and hence higher fixed asset turnover ratio. There is also a significant difference in capital intensity requirements of the industries.

Written by Obaidullah Jan, ACA, CFA and last modified on