Fixed Asset Turnover Ratio (FAT)
Fixed asset turnover ratio (FAT) is an indicator measuring a business efficiency in using fixed assets to generate revenue. The ratio compares net sales with its average net fixed assets—which are property, plant, and equipment (PPE) minus the accumulated depreciation. By doing this calculation, we can determine the amount of income made by a company per dollar invested in net fixed assets.
A high FAT ratio shows that a company is decently managing its fixed assets to generate sales. However, FAT alone can’t be the sole indicator of company profitability. If a business is in an industry where it’s not necessary to have large physical assets investments, FAT may give the wrong impression. This is the case since the amount of the fixed asset is not that big in the first place. That’s why it’s vital to use other indicators to have a more comprehensive view.
Fixed Asset Turnover Ratio Formula
Net sales refer to the amount of gross revenue minus returns, allowances, and discounts. Returns happen when items that consumers bought are returned to the company for a full refund. Refunding means the company is having reduced revenue. Allowances are cost reductions that customers receive for special reasons.
For instance, if a buyer complains that they accepted a functional but damaged product, the company may offer the buyer a partial refund option to settle the case.
This is different from returns that require the buyer to return the product for full reimbursement. Discounts are price deductions of items from the usual amount. To put it simply, net sales are the ‘real’ amount of gross revenue that the company receives.
People sometimes having trouble differentiating net sales with net income. With net sales, gross profit is only deducted by expenses that are directly related to the consumer. It does not take into account other expenses such as the cost of goods sold (COGS), operating expenses, and taxes. On the other hand, net income subtracts any expenses necessary to generate income for the company. The figure for net sales often can be found on the top line of a company’s income statement, while net income is always at the bottom line.
Average fixed assets are the next variable we need. To obtain the value of the variable, we need to sum up the net fixed assets’ beginning balance with the net fixed assets’ ending balance, then divide the result by 2. To get a better understanding, take a look at this formula:
Both beginning and ending balances refer to the value of fixed assets minus its accumulated depreciation, in other words, the net fixed assets. The beginning balance is the value of net fixed assets at the beginning of the balance period, whereas the ending balance is the value at the end of the period. This means that, in reality, the value of average fixed assets is equal to the value of the average net fixed assets.
The FAT ratio is usually calculated annually to capital-intensive businesses. Capital intensives are corporations that demand big investments in property and equipment to operate effectively. The FAT figure can tell analysts if the company’s internal management team is using its assets well.
Fixed Asset Turnover Ratio Example
An analyst wants to analyze the performance of a particular textile company in terms of using its fixed assets. After looking at the company’s income statement, she found out the total figure for the net sales is $120,000. Meanwhile, from the balance sheet, she obtains the values of NABB and NAEB to be $16,000 and $18,000 respectively. What is the FAT ratio of the company?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- FAT Ratio = unknown
- Net Sales = 120,000
- Average Fixed Assets = unknown
- NABB = 18,000
- NAEB = 16,000
To get the average fixed assets value, we need to add the beginning and ending balances and then divide the result by 2:
Now let’s use our FAT formula:
In this case, the fixed asset turnover ratio would be 7.06.
From this result, we can conclude that the textile company is generating about seven dollars for every dollar invested in net fixed assets. From a general view, some may say that this company is quite successful in taking advantage of its assets to gain profit. However, a proper analyst will first compare this result with other companies in the same industry to get a proper opinion. Furthermore, other indicators that gauge the profitability and risk of the company are also necessary to determine the performance of the business.
Fixed Asset Turnover Ratio Analysis
The FAT ratio can be useful to estimate the efficiency of a company. Fixed assets are long-term physical assets in the form of tools and property. That means, by measuring the FAT ratio, we can determine if the company is using its existing physical assets to maximize gains.
Naturally, the higher the ratio, the more efficient and profitable a business is. However, there’s no perfect number to this ratio for any company. To get a feel of the company’s condition, you can compare the business’s ratio with its peers within the same field, or, you can look at the FAT ratio value from the previous years to see if there’s any indication of growth.
As mentioned before, this metric is best used for companies that are dependent on investing in property, plant, and equipment (PP&E) to be effective. It does not have much use for business that does not rely on heavy assets. For example, using the FAT ratio for a technology company such as Twitter would be pointless since this kind of company has massively smaller long-term physical assets compared to, let’s say, an oil company.
Additionally, the FAT ratio can be unreliable if the corporation is outsourcing its production, meaning another company is producing its goods. Since they don’t own the fixed assets themselves, the FAT ratio can be very high, even if the net sales number is poor. This is one of the reasons why it’s not a wise choice to solely depend on the FAT ratio to estimate profitability.
Fixed Asset Turnover Ratio Conclusion
- The fixed asset turnover ratio is a comparison between net sales and average fixed assets to determine business efficiency.
- This formula requires two variables: net Sales and average fixed assets.
- Unlike net income, net sales only take into account expenses that are directly related to the consumers.
- While a higher ratio implies better efficiency, this number alone can’t be the sole indicator of a company’s profitability.
Fixed Asset Turnover Ratio Calculator
You can use the fixed asset turnover ratio calculator below to quickly calculate a business efficiency in using fixed assets to generate revenue by entering the required numbers.
1. What is the Fixed Asset Turnover (FAT) ratio?
The fixed asset turnover ratio (FAT) is a comparison between net sales and average fixed assets to determine business efficiency. By doing this calculation, we can determine the amount of income made by a company per dollar invested in net fixed assets.
2. What is the ideal Fixed Asset Turnover (FAT) ratio?
In the retail sector, an asset turnover ratio of 2.5 or more is generally considered good. However, a utility company or a manufacturing company might have a different ideal ratio. It is best to compare the company’s FAT ratio with its peers in the same industry to get a better idea of how efficient it is.
3. How do you interpret the Fixed Asset Turnover (FAT) ratio?
A high FAT ratio is generally good, as it implies that the company is making more money from its invested assets. However, it is important to remember that there are other factors to consider when determining a company’s profitability.
Conversely, a low FAT ratio could be a sign that the company is not using its assets efficiently. This could be due to a number of factors, such as aging equipment or an outdated business model.
4. How do you calculate the Fixed Asset Turnover (FAT) ratio?
To calculate the FAT ratio, divide net sales by average fixed assets. The formula is:
FAT = Net Sales / Average Fixed Assets
5. What is the purpose of understanding the Fixed Asset Turnover (FAT) ratio?
The FAT ratio can give us a sense of how efficient a company is at using its invested assets to generate income.
Let's say a company has a net sales value of $1,000,000 and an average fixed asset value of $500,000. This company's FAT ratio would be 2 (1,000,000 / 500,000). This means that for every dollar invested in net fixed assets, this company is generating two dollars in net sales.