A significant determinant of a company’s profitability is how well it manages fixed assets, such as production plants, properties, equipment, and other assets that contribute to the company’s potential output volume. A bigger plant may be able to handle greater production volume, but unless the company is able to turn that potential into actual sales, it’s just a wasted expense.
That’s where fixed asset turnover comes into play. Here’s what this metric looks like:
To put this metric to use, follow these steps:
Find net sales at the top of the income statement.
Find average net fixed assets by using the balance sheets of the current year and the previous year: Add the net fixed assets of the current year and previous year together, and then divide the sum by 2.
Divide net sales by the answer from Step 2 to find the fixed asset turnover.
The fixed asset turnover tells companies how well they use their fixed assets to create sales. Trends in this ratio are a critical element when companies are deciding whether or not to expand their production volume. A high fixed asset turnover means that a company is efficiently using its fixed assets.
If a company’s fixed assets are already producing at capacity and it has a high fixed asset turnover, then it may be able to expand by investing in more fixed assets to generate additional sales. A low fixed asset turnover may indicate that the company has invested in too many fixed assets and should either increase sales or sell off those assets in order to reduce costs.