Formula
Fixed Assets Turnover Ratio = Sales / Net Fixed Assets
Instead of Net Fixed Assets, one can even use the Average Net Fixed Assets. The Average Net Fixed Assets is calculated by adding the Opening and Closing Net Fixed Assets for the period and dividing the result by 2.
As per the Formula the Fixed Asset Turnover Ratio needs to be calculated on Net Fixed Assets. One can always debate whether to take Gross Fixed Assets or Net Fixed Assets for the purpose of calculating Fixed Asset Turnover Ratio. It is best to calculate it on both the ways since both will give different results and thus will have different interpretations.
The 3 examples given below explain why it is better to take Gross Fixed Assets instead of Net Fixed Assets.
Examples
Various examples of Fixed Asset Turnover Ratio (FATR) to reflect the result calculated on the basis of Gross Fixed Assets vis-à-vis Net Fixed Assets are
Scenario 1
Assuming that the Turnover over a period of 5 years has remained the same and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%.
Let us Assume that Sales for each year is $ 100,000.
Fixed Assets Purchased amounts to $ 50,000
Net Fixed Assets (i.e. after Depreciation) for the 5 Years is
Year 1 - $ 42,500
Year 2 - $ 35,000
Year 3 - $ 27,500
Year 4 - $ 20,000
Year 5 - $ 12,500
Fixed Asset Turnover Ratio on Gross Fixed Assets will be
FATR = 100,000 / 50,000 = 2
Fixed Asset Turnover Ratio on Net Fixed Assets
Year 1
FATR = 100,000 / 42,500 = 2.4
Year 2
FATR = 100,000 / 35,000 = 2.9
Year 3
FATR = 100,000 / 27,500 = 3.6
Year 4
FATR = 100,000 / 20,000 = 5
Year 5
FATR = 100,000 / 12,500 = 8
Thus FATR remains the same at 2 on Gross Fixed Assets for a period of 5 years, whereas it keeps increasing year on year if calculated on Net Fixed Assets although the Sales has remained the same. It may give an indication that the company is performing well which may not necessarily be the case. In case the expenses remain the same there would also not be any difference in the profits of the company for the 5 year period.
Scenario 2
Assuming that the Turnover has increased over a period of 5 years and Depreciation is charged on Straight Line Method Basis (Fixed Basis) @ 15%. There is additional purchase of Fixed Assets during the 5 year period.
Thus the Sales for the period of 5 years is
Year 1 - $ 100,000
Year 2 - $ 110,000
Year 3 - $ 125,000
Year 4 - $ 150,000
Year 5 - $ 200,000
Fixed Assets Purchased each year includes
Year 1 - $ 50,000
Year 2 - $ 10,000
Year 3 - Nil
Year 4 - $ 20,000
Year 5 - $ 20,000
Gross Fixed Asset Value for the period of 5 years is
Year 1 - $ 50,000
Year 2 - $ 60,000
Year 3 - $ 60,000
Year 4 - $ 80,000
Year 5 - $ 100,000
Net Fixed Asset Value for the period of 5 years is
Year 1 - $50,000 - (15% of $50,000) = $ 42,500
Year 2 - ($ 42,500 - $ 7,500) + ($10,000 - $1,500) = $ 43,500
Year 3 - ($ 35,000 - $ 7,500) + ($ 8,500 - $ 1,500) = $ 34,500
Year 4 - ($ 27,500 - $ 7,500) + ($ 7,000 - $ 1,500) + ($ 20,000 - $ 3,000) = $ 42,500
Year 5 - ($ 20,000 - $ 7,500) + ($ 5,500 - $ 1,500) + ($ 17,000 - $ 3,000) + ($ 20,000 - $ 3,000) = $ 47,500
Thus Year Wise Fixed Asset Turnover Ratio on Gross Fixed Assets and Net Fixed Assets is
Year 1
On Gross Fixed Assets
FATR = (100,000 / 50,000) = 2
On Net Fixed Assets
FATR = (100,000 / 42,500) = 2.4
Year 2
On Gross Fixed Assets
FATR = (110,000 / 60,000) = 1.8
On Net Fixed Assets
FATR = (110,000 / 43,500) = 2.5
Year 3
On Gross Fixed Assets
FATR = (125,000 / 60,000) = 2.1
On Net Fixed Assets
FATR = (125,000 / 34,500) = 3.6
Year 4
On Gross Fixed Assets
FATR = (150,000 / 80,000) = 1.9
On Net Fixed Assets
FATR = (150,000 / 42,500) = 3.5
Year 5
On Gross Fixed Assets
FATR = (200,000 / 100,000) = 2
On Net Fixed Assets
FATR = (200,000 / 47,500) = 4.2
From the example above it can be seen that FATR on Gross Fixed Assets has remained in the range of 1.8 to 2.1. Though the Turnover has doubled between Year 1 to Year 5, the company has consistently invested in Fixed Assets during these 5 years, the Gross Value of which has also doubled in these 5 years. Thus the FATR in Year 1 and Year 5 has remained the same i.e. Turnover is 2 times Gross Fixed Assets. Thus it appears that the company is capital intensive and may be heavily dependent on adding Fixed Assets to increase its turnover.
