How to Calculate Sales to Fixed Assets Ratio
The formula on how to calculate asset turnover ratio or the sales to fixed assets ratio is net sales divided by fixed assets:
Sales to Fixed Assets = Net Sales / Fixed Assets.
The numerator “sales” is the net sales and not gross sales. Net sales refer to the operating revenues earned by a firm when it sells its products or services. Net sales are the total amount of earned revenue from sales minus the expenses for the manufacture and delivery of the product or service. Gross sales, on the other hand refers to the total revenue earned when selling a product or service, without deducting the cost to manufacture, sell or distribute the product or service. Net sales play a large part in determining the income statement and cash flow statement.
The denominator fixed assets is derived from the balance sheet, and is the cost of acquiring fixed assets less depreciation of such assets. Fixed assets or non-current assets are the assets of a company not directly sold to the customer or end-users. The most common examples of fixed assets include property, plants, and equipment (PP&E). It includes all machinery used in the manufacturing process, and supporting infrastructure such as furniture, vehicles, computers, office equipment, land, and items deemed to be a fixed asset.
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What Does Sales to Fixed Assets Ratio Indicate?
Manufacturing firms widely apply sales to fixed asset ratios to determine and evaluate their ability to generate net sales from fixed-asset investments.
- A high sales to fixed asset ratio shows effective or optimal utilization of the fixed assets to generate revenue.
- An increase in sales to fixed asset ratios from previous years denotes either maturity of the fixed assets or increased production process efficiency.
- Low sales to fixed asset ratios denotes improper or inefficient utilization of assets, or obsolescence of fixed assets. Low sales to fixed asset ratios could also come from excess production capacity or interruptions in the work schedule.
- A decrease in sales to fixed asset ratios compared to a previous year might indicate creeping of process inefficiencies, damage or wearing out of machinery, obsolescence, or other factors that warrant change in the fixed asset allocation.
In general, a high sales to fixed asset ratio indicates less money tied up in fixed assets for every dollar of sales revenue, whereas a lower ratio shows over investment in plant equipment, property, and other fixed assets.
Uses of Sales to Fixed Asset Ratios
Some specific uses of the sales to fixed asset ratios include:
- Determining the level of output or returns from property, plant, and equipment purchases.
- Comparing the revenue generating ability of different asset classes.
- Benchmarking asset utilization over businesses or industries.
Ratio analysis or trend analysis is the comparison of the firm’s financial figures over a period to identify patterns and adjust business practices accordingly. Firms use the fixed assets turnover ratio to evaluate their investments and returns on investment and make the necessary changes. Investors follow the sales to fixed asset ratios to determine the effectiveness of their investment decisions, and to make future investment decisions.
Higher fixed asset turnover ratio indicates better return on investment from property, plant, and equipment. A higher ratio could, therefore, herald further investments into similar assets, whereas a low or decreasing ratio could force the firm and investors to think in terms of asset reallocation.
Shortcomings of Sales to Fixed Asset Ratios
The sales to fixed asset ratio is not a conclusive indicator of a firm’s effective utilization of fixed assets or profitability. For instance, a firm with fully depreciated fixed assets could have a high ratio due to the low book value of the fixed assets, even if the effective utilization of such assets is low or grossly inefficient. On the other hand, a highly efficient and resourceful firm could have a low sales to fixed assets ratio if the new operation has not started functioning in full capacity.
Determining effective utilization of fixed assets requires input of additional data such as the average longevity of the fixed assets and the investment of new equipment to the asset turnover ratio.