/investing13-5bfc2b8f46e0fb0026016f4d.jpg "Definition of the investment turnover rate")
How high is the investment turnover rate?
The Asset Turnover Rate (FAT) is commonly used by analysts to measure operational performance. This efficiency metric compares net sales (income statement) with fixed assets (balance sheet) and measures the ability of a company to generate net sales from its investments in property, plant and equipment (property, plant and equipment).
The balance of fixed assets is used minus the accumulated depreciation. A higher turnover rate of fixed assets indicates that a company has used investments in fixed assets effectively to generate revenue.
The central theses
- The turnover rate of fixed assets shows how efficiently a company generates sales from its existing fixed assets.
- A higher rate means that management uses its assets more effectively.
- A high FAT rate doesn’t say anything about a company’s ability to generate solid profits or cash flows.
Investment turnover rate
Understand the asset turnover rate
The formula for the turnover rate of fixed assets is:
FAT
=
Net sales
Average fixed assets
Where:
Net sales
=
Gross sales, minus returns and allowances
Average fixed assets
=
NABB
–
Ending balance
2
NABB
=
Opening balance of net fixed assets
begin {aligned} & text {FAT} = frac { text {Net sales}} { text {Average fixed assets}} & textbf {where:} & text {Net sales} = text { Gross sales, minus returns and allowances} & text {Average fixed assets} = frac { text {NABB} – text {End balance}} {2} & text {NABB} = text {Start balance of net fixed assets } end {aligned} FAT=Average fixed assetsNet salesWhere:Net sales=Gross sales, minus returns and allowancesAverage fixed assets=2NABB–Ending balanceNABB=Opening balance of net fixed assets
The ratio is often used as a metric in the manufacturing industry, which purchases significant property, plant and equipment to increase production. When a company makes such significant purchases, wise investors watch this ratio closely over the years to see if the company’s new assets reward it with higher sales.
Overall, investments in fixed assets tend to represent the largest proportion of the company’s total assets. The FAT ratio, calculated annually, reflects how efficiently a company, or more precisely the company’s management team, has used these sizeable assets to generate revenue for the company.
Interpretation of the investment turnover rate
A higher turnover rate indicates greater efficiency in managing fixed investments, but there is no precise number or range that will indicate whether a company has efficiently generated income from such investments. For this reason, it is important for analysts and investors to compare the current key figure of a company both with their own historical figures and with figures from comparable companies and / or average figures for the company’s entire industry.
Although the FAT ratio is of significant importance in certain industries, an investor or analyst must determine whether the company being studied is in the appropriate industry or industry for calculating the ratio before placing much emphasis on it.
Fixed assets vary greatly from one type of company to the next. As an example, consider the difference between an internet company and a manufacturing company. An internet company like Facebook has a significantly smaller asset base than a manufacturing giant like Caterpillar. In this example, Caterpillar’s fixed asset turnover rate is clearly more relevant and should weigh more than Facebook’s FAT rate.
Difference between the asset turnover rate and the asset turnover rate
The Asset Turnover Ratio uses total assets instead of just focusing on fixed assets, as is the case with the FAT ratio. The use of total assets serves as an indicator of a number of management decisions about investments and other assets.
Restrictions on the use of the fixed asset ratio
Companies with cyclical sales can have poorer metrics during slow periods, so the metric should be viewed over several different time periods. Additionally, management could outsource manufacturing to reduce reliance on assets and improve FAT rates while continuing to struggle to maintain stable cash flows and other business fundamentals.
Businesses with high turnover rates can still lose money because the size of fixed asset sales does not say anything about the company’s ability to generate solid profits or healthy cash flow.
