Fixed Asset Turnover

Every company or firm needs to assess the cost of production and price of sales, on a daily, weekly, monthly and even on an annual basis. Thus, there are several different types of ratios, margins and costing techniques that help people to find out one very important fact: how is the business performing? The basic rational equation that every business aims at fulfilling is maximizing the amount of sales over the amount of efforts and monetary investments that have been made. The volume of sales that exceeds investments (or costs of production incurred), is the actual profit of the firm. There are thus two principle objectives of businesses, one - maximize sales and two - minimize costs of production or expenditures. The resultant of both these objectives would be increasing profit. Asset turnover ratio is one very good method of analytical and managerial accounting that is used by firms in order to determine whether the fixed assets, their performance and their utilization is being done in the best possible manner.

Concept of Turnover Ratio

The conception of the turnover ratio lies in the general principles of cost and works accounting and financial planning. First let us understand the basic purpose of this ratio; it is calculated in order to determine whether a given fixed asset is being utilized fully to best possible extent. The fixed asset initially has a cost which is incurred by the business. This cost of the asset thus contributes to the sales. This formula or ratio, gives us a rational number of how much the asset has contributed to the sales of the company.

The general formula goes as: sales / value of asset(s)

This formula is a general formula and gives us a general or a raw figure. In practical life, the calculation of turnover ratio for fixed asset is pretty complex, and there are several variants of the formula.

Formula and Calculation

The most precise formula for fixed asset turnover is: net sales / net value of fixed assets
where: net sales = total sales (-) taxes and other related expenditures and,
net value of assets = cost price or purchase price of the fixed asset (-) depreciation (-) taxes and related expenditures.

A higher ratio indicates that the fixed assets are being utilized to the best possible extent and have delivered a maximum performance. A lower ratio indicates that the assets are being under used and their best possible performance is not being put to use. A low ratio also indicates that the recovery rate of the asset value, that is the sum of money that has been invested by the business is low, which is in fact unhealthy. People dealing in stocks and financial accounting rely on this ratio to figure out the productivity of the company in comparison to the investments made. This entire process is often also used for financial management and forecasting. It is an integral part of the entire normal and working capital management.

In practical matters, the turnover ratio can be calculated in several different manners, such as per unit turnover ratio, which is calculated for every unit produced. Some companies also estimate the ratio for one production unit or one production line, or even per employee. Basically a turnover ratio for fixed asset is highly instrumental in indicating where a particular asset or production unit is under performing or is just reaching a break even point.