What Is the Fixed Asset Turnover Ratio?

What Is the Fixed Asset Turnover Ratio?

Let me explain the fixed asset turnover ratio, or FAT, directly to you. This ratio measures operating performance by comparing net sales from your income statement to fixed assets on your balance sheet.

FAT tells you how well a company generates net sales from its fixed-asset investments, specifically property, plant, and equipment (PP&E). If you see a higher fixed asset turnover ratio, it means the company has effectively used those investments to drive sales.

Key Takeaways

Understand that the fixed asset turnover ratio reveals how efficiently a company generates sales from its existing fixed assets. You calculate FAT by dividing net sales by the average balance in fixed assets. A higher ratio indicates that management is using its fixed assets more effectively.

Fixed Asset Turnover Ratio Formula

Here's the formula you need: FAT equals net sales divided by average fixed assets. Net sales are gross sales minus returns and allowances. Average fixed assets are the beginning fixed assets plus ending fixed assets, divided by two.

This ratio is commonly used in manufacturing industries where companies make large purchases of PP&E to boost output. As an investor, you should monitor this ratio over years to check if new fixed assets lead to increased sales.

Fixed assets often represent the biggest part of a company's total assets. The FAT ratio, calculated annually, shows how efficiently a company uses these assets to generate revenue. Remember, the fixed asset balance is net of accumulated depreciation.

Interpreting FAT

A higher turnover ratio means greater efficiency in managing fixed-asset investments. When analyzing, compare a company's recent ratio to its historical ones, to peers, or to industry averages.

Fixed assets differ greatly between company types. For instance, a tech company like Meta has a much smaller fixed asset base than a manufacturing giant like Caterpillar. In such cases, Caterpillar's FAT ratio is more relevant for analysis than Meta's.

Fixed Asset Turnover Ratio vs. Asset Turnover Ratio

The asset turnover ratio uses total assets instead of just fixed assets. It reflects management's decisions on all capital expenditures and other assets.

A company's asset turnover ratio will be smaller than its fixed asset turnover ratio because the denominator is larger while the numerator remains the same. Conceptually, there's a wider gap between sales and total assets than between sales and a subset of assets.

Manufacturing companies often prefer the FAT ratio to assess capital investment performance. Companies with fewer fixed assets, like retailers, might focus more on other assets such as inventory.

Limitations of the FAT

Companies with cyclical sales may show low ratios in slow periods, so analyze the ratio over several periods. Management might outsource production to improve the FAT ratio but still face issues with cash flows and fundamentals.

Companies with strong ratios should review all profit and cash flow drivers. FAT only considers net sales and fixed assets; it ignores company-wide expenses. There can also be timing differences between collecting sales and acquiring assets.

The fixed asset turnover ratio is mainly a comparative tool. You'll get the most insight by comparing it over time to spot trends.

Example

Take Amazon's Q3 2022 balance sheet: It reported $177.2 billion in property and equipment net of depreciation as of September 30, 2022, and $160.3 billion as of December 31, 2021. Assuming these are starting and ending balances, the average fixed assets were $168.75 billion.

Amazon's net sales for the period ending September 2022 were $364.8 billion. Dividing that by the average fixed assets gives a FAT ratio of 2.16. This means for each dollar of fixed assets, Amazon generated $2.16 in net sales.

What Is a Good Fixed Asset Turnover Ratio?

Fixed asset turnover ratios vary by industry and company size. Evaluate against the industry average and competitors' ratios. A good ratio will be higher than both.

Should the Fixed Asset Turnover Ratio Be High or Low?

Aim for a higher ratio, as it means the company earns more money per dollar invested in fixed assets.

What Is the Main Downside to the Fixed Asset Turnover Ratio?

The ratio doesn't include any company expenses, so it doesn't indicate profitability. A company might have high sales and efficient asset use but still face high variable or administrative costs.

The Bottom Line

The fixed asset turnover ratio helps determine if a company efficiently uses fixed assets to drive net sales. Calculate it by dividing net sales by the average fixed assets balance for the period.