Productivity of Fixed Assets

I remember a client a few years ago who tended to make what he considered bargain purchases of equipment. Often the purchases were large enough that they needed to be capitalized. Unfortunately much of what he bought turned out to be useless and ended up sitting around the building like an over-grown paperweight. He may have still thought these purchases were a good idea, but they certainly weren’t producing a decent return. In fact, they were producing no return whatsoever and were nothing more than a waste of financial resources. So, what should you expect out of your fixed assets?

Fixed Asset Turnover

The fixed asset turnover is calculated as:

Fixed Asset Turnover = Total Sales / Net Fixed Assets

Net fixed assets are the costs of fixed assets less accumulated depreciation. Using the same information we used in a previous posting for return on assets, let’s consider the following financial statements:

ROA calculation

Here we see the sales are $10,000,000 and the net fixed assets are $375,000. So the calculation of fixed asset turnover is:

Fixed Asset Turnover = Sales / Net Fixed Assets = $10,000,000 / $375,000 = 26.67

The fixed asset turnover is a multiple of annualized sales. It shows the sales being produced by each dollar of fixed assets. Granted this is an overall calculation and can be distorted if there are fixed assets that are producing disproportionately one way or the other. For example, at the beginning of this article I mentioned the former client with a propensity for purchasing fixed assets that were never used. Obviously, in a case like that the overall calculation is skewed as the fixed assets actually used were producing better than this calculation would indicate.

It is common for a company considering a fixed asset purchase to evaluate the expected sales growth or cost savings that can be anticipated as a result of the purchase. That is a good practice, as long as these estimates are made conservatively. Outrageous claims of increased sales or reduced expenses will only cause management to make decisions that will come back to bite them.

Are Your Fixed Asset Producing

In light of the above, do you know if your fixed assets are producing adequate sales? Drilling down a little, do you know this on a fixed asset group or even individual fixed asset level? Do you have realistic expectations before you commit to purchase a fixed asset?

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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