Companies with a higher FAT ratio are generally considered to be more efficient than companies with low FAT ratio. Keep in mind that a high or low ratio doesn’t always have a direct correlation with performance. There are a few outside factors that can also contribute to this measurement. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
Formula and Calculation of the Asset Turnover Ratio
- So, if a car assembly plant needs to install airbags, it does not keep a stock of airbags on its shelves but receives them as those cars come onto the assembly line.
- Total sales or revenue is found on the company’s income statement and is the numerator.
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- The average value of the assets for the year is determined using the value of the company’s assets on the balance sheet as of the start of the year and at the end of the year.
As the company grows, the asset turnover ratio cfo meaning measures how efficiently the company is expanding over time; especially compared to the rest of the market. Although a company’s total revenue may be increasing, the asset turnover ratio can identify whether that company is becoming more or less efficient at using its assets effectively to generate profits. Investments in fixed assets tend to represent the largest component of a company’s total assets. The FAT ratio, calculated annually, is constructed to reflect how efficiently a company uses these substantial assets to generate revenue for the firm.
Investors use this ratio to compare similar companies in the same sector or group to determine who’s getting the most out of their assets. The asset turnover ratio is calculated by dividing net sales or revenue by the average total assets. FAT measures a company’s ability to generate net sales from its fixed-asset investments, namely property, plant, and equipment (PP&E).
Fixed Asset Turnover Ratio Analysis
Sometimes, investors and analysts are more interested in measuring how quickly a company turns its fixed assets or current assets into sales. In these cases, the analyst can use specific ratios, such as the fixed-asset turnover ratio or the working capital ratio to calculate the efficiency of these asset classes. The working capital ratio measures how well a company uses its financing from working capital to generate sales or revenue. The fixed asset turnover ratio formula measures the company’s ability to generate sales using fixed assets investments. One may calculate it by dividing the net sales by the average fixed assets. The asset turnover ratio helps investors understand how effectively companies are using their assets to generate sales.
The ratio is typically calculated on an annual basis, though any time period can be selected. A low fixed asset turnover ratio indicates that a business is over-invested in fixed assets. A low ratio may also indicate that a business needs to issue new products to revive its sales.
Low vs. High Asset Turnover Ratios
The fixed asset turnover ratio is useful in determining whether a company uses its fixed assets to drive net sales efficiently. It is calculated by dividing net sales by the it’s a fair cop definition and meaning average balance of fixed assets of a period. This ratio compares net sales displayed on the income statement to fixed assets on the balance sheet.
Just-in-time (JIT) inventory management, for instance, is a system whereby a firm receives inputs as close as possible to when they are needed. So, if a car assembly plant needs to install airbags, it does not keep a stock of airbags on its shelves but receives them as those cars come onto the assembly line. As with all financial ratios, a closer look is necessary to understand the company-specific factors that can impact the ratio. Such ratios should be viewed as indicators of internal or competitive advantages (e.g., management asset management) rather than being interpreted at face value without further inquiry.
Limitations of the FAT
The company should either replace such assets and look for more innovative projects or upgrade them so as to align them with the objective of the business. A technology company like Meta has a significantly smaller fixed asset base than a manufacturing giant like Caterpillar. In this example, Caterpillar’s fixed asset turnover ratio is more relevant and should hold more weight for analysts than Meta’s FAT ratio. A high asset turnover ratio indicates a company that is exceptionally effective at extracting a high level of revenue from a relatively low number of assets. As with other business metrics, the asset turnover ratio is most effective when used to compare different companies in the same industry.