Asset-Backed Commercial Paper
In the previous articles, we have already read about commercial papers and why they are an important segment of the money market. In most cases discussed earlier, commercial papers were related to unsecured debt. However, this need not always be the case. It is possible for commercial paper to be backed by other securities or […]
How Loss Aversion Affects Investment Decisions
Behavioral financial analysts have conducted a significant amount of research in order to understand how investors process loss. In the process, they have found out that most investors have an innate aversion to losses. This causes them to make wrong decisions while investing. In this article, we will have a closer look at what loss […]
The Freemium Model – Different Types of Freemium Models
In the modern world, more and more start-ups are selling products and services related to information technology. These companies either bring about a digital revolution in existing businesses or create a totally new product category. Most of these new businesses sell something intangible. Hence, the traditional distribution models are no longer effective. Web-based companies cannot […]
Intrinsic Value and Mispricing
The whole objective of equity valuation is to find mispriced securities. Investors can make abnormal profits when they find securities which are lower than their intrinsic worth trading in the market. However, the concept of mispricing and intrinsic value is misunderstood to say the least. What the average person considers as mispricing is at best […]
Exorbitant Privilege: US Dollar
The financial community of the world is at a consensus that the current economic system provides the United States government with exorbitant privileges. This means that the system does not treat all countries equally. Rather it provides an unfair advantage to the United States because the dollar is the reserve currency of the world. The […]
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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