Should Fixed Asset Turnover Ratio Be High or Low?

When evaluating a company's performance, one important ratio to consider is the fixed asset turnover (FAT) ratio. This metric provides insight into how efficiently a business uses its assets to generate revenue. But should this ratio be high or low? In this article, we'll explore the significance of FAT and what it means for your business.

The asset turnover metric falls short in being distorted by significant one-time capital expenditures (Capex) and asset sales. This is because such events can artificially inflate or deflate a company's asset base. For instance, if a company invests heavily in new equipment, its assets will increase temporarily, resulting in a higher FAT ratio even if the investment doesn't generate additional revenue.

In other words, this metric answers the question, 'How much in revenue does the company generate per dollar of assets owned?' For example, if the total turnover of a company is 1.0x, that means its net sales are equivalent to the average total assets in the period. Generally, a higher FAT ratio indicates that a company is more efficient at using its assets to generate revenue.

On the other hand, a low FAT ratio may suggest that management's operating capital spending has been inefficient, leading to potential losses due to misallocated capital. This inefficiency can eventually show up on financials via lower profitability and free cash flow.

The asset turnover ratio is calculated by dividing net sales by the average balance of total assets belonging to the company (i.e., the average between the beginning and end of period asset balances). This ratio provides a snapshot of how well a business utilizes its asset base to generate sales.

In conclusion, while it may seem intuitive that a higher FAT ratio is better, there are situations where a lower ratio can be beneficial. Ultimately, the goal is to strike a balance between investing in assets and generating revenue efficiently. By analyzing your company's FAT ratio, you can identify areas for improvement and make data-driven decisions to optimize performance.

Should fixed asset turnover ratio be high or low