How well is a company maintaining and managing its fixed assets? The Repairs to Fixed Assets ratio gives important clues.
Acquiring new equipment is no doubt a major undertaking that requires substantial spending. Such undertakings can use available cash, necessitate the taking on of large loans, and may impede cash flow, which is why businesses may continue to repair and prop-up the old equipment in order to delay making big money purchases. However, constantly repairing old equipment may be a waste of resources. The repair expense to fixed assets ratio can give important clues to how well a company is managing its assets.
How to Calculate the Repairs to Fixed Assets Ratio
Owing to the fact that the repairs expenses aren’t always given as a line item in the financial reports accessing the necessary figures to calculate the ratio may be impossible except that the analyst has access to the journals. In any case, the formula for the Repairs to Fixed Assets Ratio is as follows:
= Total repairs and maintenance expenses / Total fixed assets before depreciation
How to Interpret the Repairs to Fixed Assets Ratio
If a high percentage of the asset’s original value is being spent on repairs, one may conclude that the assets in question should be replaced or upgraded. However, there are a number of factors that may cause this number to be high, and not least among these factors is operating certain equipment in a harsh environment. One good example would be diamond-mining equipment. Digging and excavating diamond rocks is tough stuff that can quickly wear down the buckets and hydraulic systems of the toughest and newest excavators, which would necessitate more frequent repairs.
In other instances, not replacing high-maintenance equipment may signal that the company is having trouble raising the finances to purchase new equipment. While this is understandable in an environment when there is a credit squeeze, the company's trouble raising cash from its own operations or from external sources may be an indication that there are more systematic problems in the company that could make it a risky investment.
In general, business with relatively high repairs ratios can be said to be running inefficiently and would need to reinvest in newer, more efficient, and cost-effective equipment to reduce the cost disadvantage. It may also suggest that inferior equipment were purchased to start with.
Pitfalls of Using the Ratio
One has to be careful in how one interprets this ratio, though, as the same ratio can signal several positives and on another hand reveal negatives as well. For instance, a low repair ratio normally suggests that reliable and durable assets are being used. That same low ratio may be caused by management’s deliberate attempt to manipulate the ratio by delaying repairs until the next accounting period or in anticipation of an outright replacement of old assets.
In addition, the salaries of repair staff may be booked under general overhead expenses, which would make it impossible to calculate the true figure from the financial statements. The ratio may also remain relatively high if the company has permanent repair staff on the payroll, since they need to be compensated whether or not the equipment breaks down.
While a high repair to fixed assets ratio may suggest that management is doing a good job of maintaining its assets or that it had purchased high-quality equipment at the onset, the ratio may also indicate that the assets are deteriorating at an unusually high rate because of adverse and extreme working conditions. As outlined above, there are pitfalls in using this ratio to analyze a company’s management of fixed assets. To properly analyze the repair expenses to fixed assets ratio it may be necessary to have some insight into how the repair expenses are accounted for, how repairs personnel are contracted, and the company's repairs schedule to get a meaningful understanding of the cost effectiveness of keeping the current batch of fixed assets.
“How to Interpret the Repairs to Fixed Assets Rati-factory machinery-pic" dicktay2000 from Flickr.
"Interpreting the repair expenses to fixed assets ratio-pic" Loozrboy from Flickr.