What is Sports Franchising?
We all know that professional sports teams are run like a business across the globe. This means that these sports teams have professional marketing agents, an executive team, and a finance team and operate like a full-fledged organization. These professional teams are often referred to as sports franchises. Football clubs in the English Premier League, […]
Merchant Cash Advance in the Retail Sector, Its Advantages and Disadvantages
The retail sector has some unique financial needs. There are various types of retail establishment across the world which use different types of arrangements to fund their day-to-day capital needs. The larger and more sophisticated retail chains have access to formal loans from banks. However, this may not be the case for small and medium […]
How Do Funds Transfer Systems Work
Domestic Funds Transfer It is common for individuals and entities to transfer funds to their friends, family, business partners, and associates. The way funds transfer works is opaque to the individual as he or she simply instructs the banks (or enables funds transfer when using online banking) and waits for confirmation from the other end […]
Is the Lyft IPO Overpriced?
Lyft is one of the most famous tech unicorns in the world. There was tremendous amount of buzz in the market regarding the Lyft IPO. This is the reason that the company has been able to garner a valuation of close to $24 billion. This astronomical valuation is despite the fact that the company has […]
Base Rate Fallacy
The human mind is riddled with several fallacies. When human beings make investment decisions, they are battling a wide variety of biases. In this module, we have discussed a lot of these biases. The base rate fallacy is another important bias that directly and profoundly impacts the investors’ decision-making process. The base rate fallacy is […]
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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