Return on Equity (ROE) – Meaning, Formula, Assumptions and Interpretation
Return on Equity (ROE) is probably the most important number in the financial universe. Every company is driven by profit and Return on Equity (ROE) is considered to be the best indicator of the profitability of a company. Debt holders just want to get their interest and principle back i.e. they will obtain a fixed […]
Advantages of a Digital Depository System
In the previous article, we learned about what a digital depository system is and how it functions. We also understood the roles and responsibilities played by each participant in the system. In this article, we will continue to understand the depository system further. We will have a look at some of the functions which are […]
Apple’s Acquisition of Intel’s Modem Business
Apple is one of the largest manufacturers of mobile phones in the world. The company is the largest in the world and recently became the first one to cross the $1 trillion market capitalization mark. The company has been recently engaged in a quagmire with Qualcomm, which is one of its suppliers. Finally, Apple had […]
Misconceptions about Personal Finance
The importance of financial planning at an individual and family level cannot be overstated. For years, people and even governments have been trying to inculcate this habit into the masses. However, they have found it difficult to do so. This is because there are several misconceptions related to personal finance, which are common among people. […]
Intrinsic Value and Mispricing
The whole objective of equity valuation is to find mispriced securities. Investors can make abnormal profits when they find securities which are lower than their intrinsic worth trading in the market. However, the concept of mispricing and intrinsic value is misunderstood to say the least. What the average person considers as mispricing is at best […]
Fixed assets i.e. property, plant and equipment represent the single largest investment any company makes in its operations. It is therefore important that a company keeps a close eye on whether these investments are performing well and generating adequate revenue and profit to justify the expenditure. While it is impossible to come up with a single number that explains the efficiency of the company in utilizing its fixed assets, the fixed asset turnover ratio comes close. Here are the details of this ratio.
Fixed Asset Turnover Ratio = Sales Revenue / Total Fixed Assets (Average of the two balance sheets)
The fixed asset turnover ratio is best applied when there is adequate context. Dividing the two numbers and getting a third number makes little sense unless you can compare it with something.
The best comparison in with the company’s past records itself. If the company has made a new addition to the fixed assets, one can find out the new fixed asset turnover ratio and compare it with the old fixed asset turnover ratio and see if there have been any substantial improvements as a result of the addition. Efforts must be made to ensure that extraneous variables like general condition of the economy et al are nullified to get a true picture of the state of affairs.
Another popular comparison is to benchmark the fixed asset turnover ratio of a company with those of other companies in the same industry. Same industry is important because different industries have different fixed capital requirements.
Service oriented companies usually have less fixed capital requirement as compared to heavy manufacturing. Some companies use an average of the other companies in the industry to benchmark their performance against whereas others look at the best in the field and try to compete with them.
The fixed asset turnover ratio provides the best estimate of the operating leverage of the firm. If increases in fixed assets lead to disproportionate increases in sales, then the firm has a high operating leverage. In some ways therefore, a wildly fluctuating fixed asset turnover ratio is a measure of high risk that a company is facing.
Also investors should be wary of changes in the revenue policy. Changes in the revenue policy can affect sales which can make this ratio artificially higher or lower thereby distorting the investors perception of the efficiency of the company.
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