Understanding the Fixed Asset Turnover Ratio: Efficiency & Formula Explained

What Is the Fixed Asset Turnover Ratio?

The fixed asset turnover ratio (FAT) measures operating performance. This ratio compares net sales displayed on the income statement to fixed assets on the balance sheet. The formula uses net sales and average fixed assets to assess efficiency. A higher ratio is beneficial for companies because this indicates an effective use of fixed-asset investments. This ratio is more applicable to industries like manufacturing than to retailers. The ratio is useful to analyze trends and as a benchmark against peers.

FAT shows how well a company generates sales from its investments in property, plant, and equipment (PP&E). A higher turnover ratio means the company is using its fixed assets well to generate sales.  

How to Calculate the Fixed Asset Turnover Ratio

$\begin{aligned}&\text{FAT}=\frac{\text{Net Sales}}{\text{Average Fixed Assets}}\\&\textbf{where:}\\&\text{Net Sales}=\text{Gross sales}-\text{Returns and allowances}\\&\text{Average Fixed Assets}=\frac{\text{Beginning Fixed Assets}+\text{Ending Fixed Assets}}{2}\end{aligned}$​FAT=Average Fixed AssetsNet Sales​where:Net Sales=Gross sales−Returns and allowancesAverage Fixed Assets=2Beginning Fixed Assets+Ending Fixed Assets​​

The ratio is commonly used as a metric in manufacturing industries that make substantial purchases of PP&E to increase output. Investors track this ratio over time to see if new fixed assets lead to more sales. 

Fixed assets often make up the biggest part of a company’s assets. The FAT ratio, calculated yearly, shows how efficiently a company uses its assets to generate revenue.

Understanding and Analyzing the Fixed Asset Turnover Ratio

A higher turnover ratio indicates greater efficiency in managing fixed-asset investments. Analysts and investors compare a company’s recent ratio to past ratios, peers, or industry averages.

Fixed assets vary drastically from one company type to the next. 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.

Comparing Fixed Asset Turnover Ratio and Asset Turnover Ratio

The asset turnover ratio uses total assets instead of focusing only on fixed assets. Using total assets reflects management’s decisions on all capital expenditures and other assets.

The asset turnover ratio is usually smaller than the fixed asset turnover ratio because it uses a larger denominator. This is because there is a bigger gap between sales and total assets than between sales and just fixed assets.

Manufacturing companies often favor the FAT ratio over the asset turnover ratio to determine how well capital investments perform. Companies with fewer fixed assets, such as retailers, may be less interested in the FAT compared to how other assets, such as inventory, are utilized.

Limitations of the Fixed Asset Turnover Ratio

Companies with seasonal sales might have low ratios during slow times, so it’s best to analyze the ratio over several periods. Companies might outsource to improve their FAT ratio, but still struggle with cash flow and other basics.

Companies with strong ratios may review all aspects that generate solid profits or healthy cash flow. FAT considers only net sales and fixed assets, ignoring company-wide expenses. In addition, there may be differences in the cash flow between when net sales are collected and when fixed assets are acquired.

The fixed asset turnover ratio is only useful as a comparative tool. The ratio is most insightful when tracked over time for trends.

Real-World Example of a Fixed Asset Turnover Ratio Calculation

In the Q3 2022 balance sheet below, Amazon reported owning $177.2 billion of property and equipment net of depreciation as of Sept. 30, 2022, and $160.3 billion of property and equipment as of Dec. 31, 2021. In this simplified example, assume these are starting and ending fixed asset balances. This means Amazon’s average fixed assets for this example were $168.75 billion.

As shown in the image below, Amazon also reported its net income for these periods. For the fixed asset turnover ratio, it doesn’t necessarily matter what the prior year’s sales were. To calculate this year’s ratio, the current net sales for the period ending in September 2022 of $364.8 billion apply.

To calculate the fixed asset turnover ratio, the $364.8 billion of net sales is divided by the $168.75 average balance of fixed assets. Therefore, the company’s fixed asset turnover ratio is 2.16. For each dollar of fixed assets, Amazon generated $2.16 of net sales.

The Bottom Line

The fixed asset turnover (FAT) ratio is a measure of how efficiently a company generates sales from its fixed-asset investments. It is a useful metric when analyzing financial performance. A higher FAT ratio indicates more efficient utilization of fixed assets to generate sales.

To calculate the FAT ratio: divide net sales by the average fixed assets. This calculation is important for investors and analysts. Comparing the FAT ratio over time and against industry peers is a great way to gain a better understanding of a company’s asset management efficiency. There are potential limitations of the FAT ratio, such as its inability to factor in company-wide expenses and cash flow timing, which can affect profitability interpretations. The FAT ratio, while useful, should be analyzed alongside other financial metrics for a comprehensive understanding of a company’s financial health.