The fixed asset turnover ratio (FAT) is, in general, used by analysts to measure operating performance. This efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures a company's ability to generate net sales from its fixed-asset investments, namely property, plant, and equipment (PP&E).
The fixed asset balance is used as a net of accumulated depreciation. A higher fixed asset turnover ratio indicates that a company has effectively used investments in fixed assets to generate sales.
Key TakeawaysThe fixed asset turnover ratio reveals how efficient a company is at generating sales from its existing fixed assets.The fixed asset turnover ratio is calculated by dividing net sales by the average balance in fixed assets.A higher ratio implies that management is using its fixed assets more effectively.A high FAT ratio does not tell anything about a company's ability to generate solid profits or cash flows.The fixed asset turnover is similar to other turnover ratios such as the assets turnover ratio, though the fixed asset turnover ratio uses a subset of assets to compare a company's activity against.:max_bytes(150000):strip_icc()/TermDefinitions_Fixed_Asset_Turnover_Ratio_-d269a3bf50b040dcb50552ac0ac79e4f.jpg)
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Fixed Asset Turnover Ratio FormulaThe formula for the fixed asset turnover ratio is:
FAT=Net SalesAverage Fixed Assetswhere:Net Sales=Gross sales−Returns and allowancesAverage Fixed Assets=Beginning Fixed Assets+Ending Fixed Assets2\begin{aligned}&\text{FAT}=\frac{\text{Net Sales}}{\text{Average Fixed Assets}}\\&\textbf{where:}\\&\text{Net Sales}=\text{Gross sales}-\text{Returns and allowances}\\&\text{Average Fixed Assets}=\frac{\text{Beginning Fixed Assets}+\text{Ending Fixed Assets}}{2}\end{aligned}FAT=Average Fixed AssetsNet Saleswhere:Net Sales=Gross sales−Returns and allowancesAverage Fixed Assets=2Beginning Fixed Assets+Ending Fixed Assets
The ratio is commonly used as a metric in manufacturing industries that make substantial purchases of PP&E in order to increase output. When a company makes such significant purchases, wise investors closely monitor this ratio in subsequent years to see if the company's new fixed assets reward it with increased sales.
Overall, investments in fixed assets tend to represent the largest component of the company’s total assets. The FAT ratio, calculated annually, is constructed to reflect how efficiently a company, or more specifically, the company’s management team, has used these substantial assets to generate revenue for the firm.
Interpreting the Fixed Asset Turnover RatioA higher turnover ratio is indicative of greater efficiency in managing fixed-asset investments, but there is not an exact number or range that dictates whether a company has been efficient at generating revenue from such investments. For this reason, it is important for analysts and investors to compare a company’s most recent ratio to both its own historical ratios and ratio values from peer companies and/or average ratios for the company's industry as a whole.
Though the FAT ratio is of significant importance in certain industries, an investor or analyst must determine whether the company under study is in the appropriate sector or industry for the ratio to be calculated before attaching much weight to it.
Fixed assets vary drastically from one company type to the next. As an example, consider the difference between an internet company and a manufacturing company. An internet company, such as Meta (formerly Facebook), has a significantly smaller fixed asset base than a manufacturing giant, such as Caterpillar. Clearly, in this example, Caterpillar’s fixed asset turnover ratio is of more relevance and should hold more weight than Meta’s FAT ratio.
Fixed Asset Turnover Ratio vs. Asset Turnover RatioThe asset turnover ratio uses total assets instead of focusing only on fixed assets as done in the FAT ratio. Using total assets acts as an indicator of a number of management’s decisions on capital expenditures and other assets.
A company's asset turnover ratio will be smaller than its fixed asset turnover ratio because the denominator in the equation is larger while the numerator stays the same. It also makes conceptual sense that there is a wider gap between the amount of sales and total assets compared to the amount of sales and a subset of assets.
Manufacturing companies often favor the fixed asset turnover ratio over the asset turnover ratio because they want to get the best sense in how their capital investments are performing. Companies with fewer fixed assets such as a retailer may be less interested in the FAT compared to how other assets such as inventory are being utilized.
Because the fixed asset ratio is best used as a comparative tool, it's crucial that the same method of picking information is used across periods.
Limitations of Using the Fixed Asset RatioCompanies with cyclical sales may have worse ratios in slow periods, so the ratio should be looked at during several different time periods. Additionally, management could be outsourcing production to reduce reliance on assets and improve its FAT ratio, while still struggling to maintain stable cash flows and other business fundamentals.
Companies with strong asset turnover ratios can still lose money because the amount of sales generated by fixed assets speak nothing of the company's ability to generate solid profits or healthy cash flow. The fixed asset ratio only looks at net sales and fixed assets; company-wide expenses are not factored into the equation. In addition, there are differences in the cashflow between when net sales are collected and when fixed assets are invested in.
Like other financial ratios, the fixed ratio turnover ratio is only useful as a comparative tool. For instance, a company will gain the most insight when the fixed asset ratio is compared over time to see the trend of how the company is doing. Alternatively, a company can gain insight into their competitors by evaluating how their fixed asset ratio compares to others.
Example of Fixed Asset Turnover RatioIn the Q3 2022 balance sheet below, Amazon reported owning $177.2 billion of property and equipment net of depreciation as of Sept. 30, 2022. It also reported owning $160.3 billion of property and equipment as of Dec. 31, 2021. In this simplified example, we'll assume these are our starting and ending fixed asset balances. This means Amazon's average fixed assets for this example was $168.75 billion.
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Amazon Balance Sheet, Q3 2022.Shown in the image below, Amazon also reported its net income for these periods. For the fixed asset turnover ratio, it doesn't necessarily matter what prior year sales were unless we were calculating last year's ratio. To calculate this year's ratio, all we need is the current net sales for the period ending in September 2022. This is $364.8 billion.
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Amazon Income Statement, Q3 2022.To calculate the fixed asset turnover ratio for Amazon, the $364.8 billion of net sales would be divided by the $168.75 average balance of fixed assets. Therefore, the company's fixed asset turnover ratio is 2.16. This means that for this period, for every dollar of fixed assets Amazon owned, it generated $2.16 of net sales.
What Is a Good Fixed Asset Turnover Ratio?Fixed asset turnover ratios widely vary by industry and company size. Therefore, there is no single benchmark all companies can use as their target fixed asset turnover ratio. Instead, companies should evaluate what the industry average is and what their competitor's fixed asset turnover ratios are. A good fixed asset turnover ratio will be higher than both.
Should the Fixed Asset Turnover Ratio Be High or Low?Companies with higher fixed asset turnover ratios earn more money for every dollar they've invested in fixed assets. For most, a higher fixed asset turnover ratio is better.
What Is the Main Downside to the Fixed Asset Turnover Ratio?The fixed asset turnover ratio does not incorporate any company expenses. Therefore, the ratio fails to tell analysts whether or not a company is even profitable. A company may be generating record levels of sales and efficiently using their fixed assets; however, the company may also have record levels of variable, administrative, or other expenses. The fixed asset turnover ratio also doesn't consider cashflow, so companies with good fixed asset turnover ratios may also be illiquid.
The Bottom LineThe fixed asset turnover ratio is useful in determining whether a company is efficiently using its fixed assets to drive net sales. The fixed asset turnover ratio is calculated by dividing net sales by the average balance of fixed assets of a period. Though the ratio is helpful as a comparative tool over time or against other companies, it fails to identify unprofitable companies.