What is the capital turnover rate?
The fixed asset turnover rate (FAT) is generally used by analysts to measure operational performance. This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures the capacity of a company to generate net sales from its fixed asset investments, namely tangible fixed assets (PP&E).
The balance of fixed assets is used as a deduction from accumulated depreciation. In general, a higher capital turnover ratio indicates that a business has used capital investments more effectively to generate revenue.
The fixed asset turnover ratio formula is
TheFAT=Average fixed assetsNet salesTheor:Net sales=Gross sales, less returns and allowancesAverage fixed assets=2NABB–Closing balanceTheNABB=Initial balance of net fixed assetsTheThe
Fixed asset turnover ratio
What does the turnover rate of fixed assets tell you?
The capital turnover ratio is commonly used as a measure in manufacturing industries that purchase substantial tangible capital assets to increase production. When a business makes such large purchases, savvy investors carefully monitor this ratio over the next several years to see if the company’s new fixed assets reward it with increased sales.
Overall, capital investment tends to be the largest component of a company’s total assets. The FAT ratio, calculated annually, is designed to reflect the efficiency with which a business, or more specifically its management team, has used these important assets to generate revenue for the business.
Interpretation of the turnover rate of fixed assets
A higher turnover rate indicates greater efficiency in managing capital investments, but there is not an exact number or range that dictates whether a business has been effective in generating income from these investments. For this reason, it is important for analysts and investors to compare a company’s most recent ratio to its own historical ratios and ratio values of peer companies and / or to average ratios for the whole business industry.
Although the FAT ratio is of significant importance in some industries, an investor or analyst must determine whether the study business is in the appropriate sector or industry for the ratio to be calculated before entering it. attach a lot of weight.
Fixed assets vary considerably from one type of business to another. For example, consider the difference between an Internet business and a manufacturing business. An Internet company like Facebook has a considerably smaller capital base than a manufacturing giant like Caterpillar. Obviously, in this example, Caterpillar’s capital turnover ratio is more relevant and should have more weight than Facebook’s FAT ratio.
Key points to remember
- The fixed asset turnover rate reveals the effectiveness of a business in generating sales from its existing fixed assets.
- A higher ratio result means that management uses capital assets more efficiently.
- A high FAT ratio says nothing about a company’s ability to generate solid profits or cash flow.
Difference between fixed asset ratio and asset turnover rate
The asset turnover ratio uses total assets instead of focusing only on fixed assets as in the FAT ratio. The use of total assets acts as an indicator of a number of management decisions regarding capital expenditures and other assets.
Limits on the use of the fixed asset ratio
Companies with cyclical sales may have worse ratios during slow periods, so the ratio should be looked at for several different periods. In addition, management could outsource production to reduce dependence on assets and improve its FAT ratio, while still striving to maintain stable cash flow and other business fundamentals.
Companies with high asset turnover rates can still lose money because the amount of sales generated by capital assets says nothing about the company’s ability to generate solid profits or solid cash flows.