Asset Turnover Ratio Definition, Formula, and Method of Computation
Fixed Asset Turnover: A Critical Financial Ratio for Evaluating a Company's Efficiency
Fixed asset turnover is a significant financial ratio that demonstrates a company's ability to generate sales efficiently using its long-term assets. This ratio, expressed as revenue divided by average fixed assets, offers insight into the company's asset utilization. A higher ratio indicates superior asset efficiency.
Calculation of Fixed Asset Turnover
To compute the fixed asset turnover, one must divide revenue by average fixed assets. The revenue figure can be found in the income statement, while the fixed assets are listed as non-current assets in the balance sheet. Notably, the total fixed assets on the balance sheet are net, meaning the gross fixed assets minus accumulated depreciation.
For instance, let's analyze PT Astra Agro Lestari Tbk's (AALI) fixed asset turnover ratio for the years 2016, 2017, and 2018.
- 2016: 0.83
- 2017: 0.99
- 2018: 1.06
The Fixed Asset Turnover Ratio's Importance
A high fixed asset turnover ratio is desirable because it demonstrates the company's efficiency in utilizing its fixed assets to generate sales. However, overly high ratios could suggest the company is operating beyond its capacity, necessitating further investments in capital assets or addressing overutilization. Conversely, a low ratio may indicate operating inefficiencies but may not be problematic in capital-intensive industries.
The appropriate fixed asset turnover ratio varies across industries and does not necessarily predict a company's profitability or cash flow.
Is a High Asset Turnover Always advantageous?
While a high ratio is generally advantageous, an exceedingly high ratio might imply the company is operating beyond its capacity. To efficiently produce and sell its goods, the company may need to invest in additional capital assets, such as factories, property, or equipment.
On the other hand, a low ratio does not necessarily imply inefficiency, particularly in capital-intensive sectors where machinery and fixed assets play a significant role in production. The appropriate fixed asset turnover ratio standard for one sector may differ from another.
For example, a manufacturing company would typically have a lower fixed asset turnover ratio than an internet service company, given their contrasting asset intensities.
New entrants often report a low fixed asset turnover ratio as they invest in newer assets compared to established competitors. Additionally, companies with older assets may depreciate them over a longer period, allowing for increased depreciation and a lower book value of fixed assets.
Decreasing Fixed Asset Turnover Ratio
A decreasing fixed asset turnover ratio may signify that the company is investing excessively in property, plant, and equipment. Monitoring this ratio in subsequent years is essential to determine if the new fixed assets contribute to increased sales.
Other factors leading to a decline in the fixed asset turnover ratio include reduced industry demand, operating inefficiencies, significant depreciation or asset impairment charges, strategic shifts, seasonal or temporary factors, and business model changes.
It is crucial for companies to carefully manage their fixed assets and plan strategically to maintain or improve their fixed asset turnover ratio.
Finance is integral in understanding the significance of the Fixed Asset Turnover Ratio, a critical financial ratio in the business world. This ratio, calculated by dividing revenue by average fixed assets, provides insight into a company's asset utilization and efficiency in generating sales.
