Fixed asset turnover is one of the few ratios that earns its keep in a small business. It takes two figures that are already sitting in the accounts and tells you whether the equipment you bought is actually producing anything.
What follows sets out the formula and the reason each input is defined as it is, works the calculation on real figures, gives realistic ranges by industry, and explains the depreciation effect that makes a rising ratio look better than it is.
Key Takeaways
- Fixed asset turnover equals net sales divided by average net fixed assets, and the ratio reports the revenue generated by each dollar invested in property and equipment.
- The denominator uses the average of the opening balance and the closing balance rather than the year end balance, because a single purchase late in the year would otherwise distort the entire period.
- No universal benchmark exists, because a professional services firm can report a ratio above 15 while a capital intensive operation reports a ratio below 1, and both ratios can be healthy.
- A rising ratio does not necessarily represent improvement, because depreciation reduces the denominator in every period and an aging asset base therefore flatters the ratio.
- The useful comparison is the ratio of the business against its own ratio across several years, read alongside the amount spent on capital equipment in each of those years.
The formula
Fixed asset turnover equals net sales divided by average net fixed assets.
Each of the three inputs requires definition. Net sales means gross revenue less returns, allowances and discounts, and net sales is the figure reported at the top of the income statement rather than the figure reported at the bottom. Net fixed assets means property, plant and equipment stated after accumulated depreciation, which is the book value of those assets rather than the original cost and rather than the current market value. Average means the opening balance added to the closing balance and the total divided by two.
The averaging step is the step most frequently omitted, and the averaging step is material. Revenue accumulates across the whole of the period, while the balance sheet figure represents a single date. A machine purchased for $200,000 in December would depress a ratio calculated on the year end balance even though the machine contributed nothing to the sales recorded during that year.
A worked calculation
The figures reported by Harbor Fabrication for the year are set out below.
| Line | Amount |
|---|---|
| Net sales | $1,840,000 |
| Net fixed assets at January 1 | $612,000 |
| Net fixed assets at December 31 | $688,000 |
| Average net fixed assets | $650,000 |
Scroll sideways to see all columns.
Net sales of $1,840,000 divided by average net fixed assets of $650,000 produces a fixed asset turnover ratio of 2.83. Each dollar invested in fixed assets generated $2.83 of sales during the year. That figure carries no meaning in isolation and acquires meaning when the figure is placed alongside the equivalent figure for the preceding year.
Realistic ranges by industry
Ratios of this kind vary so widely between industries that a cross industry benchmark is actively misleading. Approximate ranges are set out below.
| Type of business | Typical range | Reason |
|---|---|---|
| Professional services and consulting | 10 and above | Almost no fixed assets are held beyond laptops and a lease |
| Software and agencies | 5 to 15 | The business model is asset light by design |
| Retail and distribution | 3 to 6 | Fixtures and vehicles are held, while the capital is committed to inventory |
| Manufacturing | 1.5 to 3 | Machinery constitutes the productive capacity of the business |
| Utilities, transport and real estate | Below 1 | Very large asset bases are held over long useful lives |
Scroll sideways to see all columns.
A manufacturer reporting a ratio of 2.5 and a consulting firm reporting a ratio of 2.5 are reporting opposite conditions. A ratio of 2.5 is ordinary for a manufacturer. A ratio of 2.5 reported by a consulting firm indicates that something large and unproductive is being carried on the balance sheet of that firm.
Comparison should therefore be made in two directions only, being comparison against the prior results of the same business across three to five years and comparison against businesses operating in the same industry.
The depreciation effect
Depreciation reduces net fixed assets in every period, irrespective of whether anything has changed in the operations of the business. Where revenue remains flat and no assets are purchased, the ratio rises of its own accord and continues rising indefinitely, because the denominator of the ratio is shrinking toward zero.
An asset that has been fully depreciated and remains in daily use carries a book value of zero. Such an asset contributes nothing to the denominator of the ratio and contributes everything to the numerator of the ratio. A company operating a plant filled with fully depreciated equipment can therefore report an impressive fixed asset turnover ratio until the point at which the equipment fails.
The protection against that misreading is straightforward. The ratio should be read alongside two further figures, being gross fixed assets stated before accumulated depreciation and the amount spent on capital equipment in each of the preceding years. A ratio that is climbing while capital expenditure sits near zero reports an aging asset base rather than improving efficiency.
Three further distortions
A large purchase made partway through the year enters the denominator immediately and begins producing revenue several months later, so the ratio falls for one year and recovers thereafter. That pattern is ordinary and does not indicate a problem.
Leasing rather than purchasing changes the denominator, because leased equipment may be recorded on the balance sheet as a right of use asset or may not be recorded on the balance sheet at all, depending on the terms of the arrangement. Two businesses with identical operations, one leasing its equipment and one owning its equipment, can therefore report materially different ratios. The treatment applied to the leases of the business should be confirmed before any comparison is drawn.
A business with a pronounced seasonal pattern may be served poorly by a two point average. Averaging the quarterly balances produces a more representative denominator for such a business.
Fixed asset turnover compared with total asset turnover
Total asset turnover places every asset in the denominator, including cash, receivables and inventory, and total asset turnover therefore measures the efficiency with which the whole balance sheet generates revenue.
Fixed asset turnover narrows the denominator to property and equipment, and that narrowing is what makes fixed asset turnover useful when a capital purchase is under consideration, because the narrower ratio isolates the question of whether the equipment is earning its place. A business carrying an inflated receivables balance will report a poor total asset turnover ratio alongside an entirely healthy fixed asset turnover ratio, and those two results point toward completely different remedies.
Reading the ratio in practice
A ratio that is falling while revenue remains flat and capital expenditure is rising indicates that capacity has been purchased and is not yet being used. That condition is acceptable for one year and warrants attention by the third year.
A ratio that is rising while capital expenditure sits near zero indicates that depreciation is producing the improvement. The age of the asset base should be established before the improvement is treated as genuine.
A ratio that is falling while revenue is falling and capital expenditure is flat does not indicate a problem with the assets of the business. The ratio in that case is reporting a sales problem.
None of the above is reliable without a fixed asset register that is current. Assets disposed of in earlier periods and never removed from the ledger inflate the denominator permanently and understate the ratio permanently. Maintaining that register accurately is the unglamorous component of asset management for a small business, and maintaining that register accurately is what makes every ratio calculated from the balance sheet trustworthy. The position of net fixed assets within the statement is shown in the balance sheet example.
Ratios like this one are only as honest as the asset register behind them, and most small business registers quietly fill up with equipment that left years ago. GlassJar tracks each asset from purchase through disposal and keeps the depreciation schedule current, so the denominator you divide by is the equipment you actually still own. See how it works.
Frequently asked questions
What is the fixed asset turnover ratio?
The fixed asset turnover ratio equals net sales divided by average net fixed assets, and the ratio measures the revenue generated by each dollar invested in property and equipment.
How are average net fixed assets calculated?
The net fixed asset balance at the start of the period is added to the net fixed asset balance at the end of the period and the total is divided by two. Net means stated after accumulated depreciation.
What is a good fixed asset turnover ratio?
The answer depends entirely on the industry. Professional services firms frequently exceed 10, manufacturers commonly report between 1.5 and 3, and capital intensive businesses report below 1. Comparison should be made against the prior results of the same business and against direct competitors.
Why is a rising ratio not necessarily favorable?
Depreciation reduces the denominator in every period. An aging and substantially depreciated asset base therefore produces a high ratio that reflects deferred replacement rather than improved efficiency.
How does fixed asset turnover differ from total asset turnover?
Total asset turnover uses every asset in the denominator, including cash, receivables and inventory. Fixed asset turnover uses only property and equipment, which isolates the question of whether capital purchases are generating revenue.
