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The rent vs. buy decision is as old as the concept of financial planning itself. There are people who have very strong views on both sides of the spectrum. There are some people who believe that owning a home is always better and that renting a house is like throwing money away. At the same […]
The Phenomenon of House Poverty
Homeownership has been at the center of every American dream for the past few decades. The conventional belief is that buying a home always turns out to be a good investment in the long run. This is the reason why owning a home is considered to be one of the biggest and the most important […]
What is Marketplace Business Model and How Does it Work?
In the previous article, we have studied about how modern start-ups have created a new form of a business model called the aggregator business model. There are several companies such as Uber and Airbnb which have been using the aggregator model successfully. However, there is another business model which has been successfully used by even […]
Accounting for Players Who Have been Promoted Internally
It is common for sporting franchises to create an internal system so that young players with high potential can be identified and groomed at an early stage. Such players form the backbone of any successful football franchise since they are cost-effective. It is common for such players to help create a disproportionately high value in […]
Financial and Economic Models used in the Equity and Currency Markets
We often read about how electronic and software based trading is the norm in stock or equity markets as well as currency and other financial markets. Indeed, anyone who is remotely connected with the stock market or for that matter any financial market would know that there are trading systems and trading software that help […]
Fixed assets i.e. property, plant and equipment represent the single largest investment any company makes in its operations. It is therefore important that a company keeps a close eye on whether these investments are performing well and generating adequate revenue and profit to justify the expenditure. While it is impossible to come up with a single number that explains the efficiency of the company in utilizing its fixed assets, the fixed asset turnover ratio comes close. Here are the details of this ratio.
Fixed Asset Turnover Ratio = Sales Revenue / Total Fixed Assets (Average of the two balance sheets)
The fixed asset turnover ratio is best applied when there is adequate context. Dividing the two numbers and getting a third number makes little sense unless you can compare it with something.
The best comparison in with the company’s past records itself. If the company has made a new addition to the fixed assets, one can find out the new fixed asset turnover ratio and compare it with the old fixed asset turnover ratio and see if there have been any substantial improvements as a result of the addition. Efforts must be made to ensure that extraneous variables like general condition of the economy et al are nullified to get a true picture of the state of affairs.
Another popular comparison is to benchmark the fixed asset turnover ratio of a company with those of other companies in the same industry. Same industry is important because different industries have different fixed capital requirements.
Service oriented companies usually have less fixed capital requirement as compared to heavy manufacturing. Some companies use an average of the other companies in the industry to benchmark their performance against whereas others look at the best in the field and try to compete with them.
The fixed asset turnover ratio provides the best estimate of the operating leverage of the firm. If increases in fixed assets lead to disproportionate increases in sales, then the firm has a high operating leverage. In some ways therefore, a wildly fluctuating fixed asset turnover ratio is a measure of high risk that a company is facing.
Also investors should be wary of changes in the revenue policy. Changes in the revenue policy can affect sales which can make this ratio artificially higher or lower thereby distorting the investors perception of the efficiency of the company.
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