Non-current assets often represent a significant proportion of the total resources controlled by a company. They are recorded in the balance sheet and held into the long-term by the business, with the intention of producing long-term economic benefits. Many items we see regarding non-current assets, such as capex, accumulated depreciation and gross PP&E, can help analysts measure the financial performance of a company and indicate where the company is heading in the future. Let’s take a look at some of the most widely used metrics:
= Capital expenditure / Sales
The capex ratio measures the investment relative to company sales. An increase in this ratio overtime would suggest future growth. If a company continues to invest in resources through increase in capital expenditure, then we would expect to see an increase in sales the following year. This pattern of continuous reinvestment of retained earnings year after year is what drives company growth and enterprise value.
“Capital expenditure (capex) can be broken down into expansion capex and maintenance capex. Expansion increases overall capacity (increase in non-current assets net) whereas maintenance simply keeps the existing activity levels operating effectively.”
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Average Age of PP&E
Accumulated depreciation / Gross PP&E
The average age ratio appraises the age of the asset (in this case PP&E) and shows the average age of assets. By measuring accumulated depreciation relative to the gross value of the asset, we can see how “old” the asset is as a percentage of its total life. A high ratio would suggest that much of the asset’s life has already been used, and the business faces an “ageing asset base”, which will require investment. Investment will mean expenses incurred, and these expenses will decrease future retained earnings and hence profits.
= Capital expenditure / Depreciation
The reinvestment ratio (sometimes referred to as the replenishment ratio) compares capex to depreciation and is an interesting indicator of the extent to which enough investment is being made into assets. In other words, are depreciating assets being replaced? Often this ratio is expressed as a multiple and a financially healthy business should expect this multiple to be greater than 1. Due to inflation, assets purchased many years ago will cost more to replace if purchased today. Depreciation is calculated at historical costs so should be a cause for concern if this ratio was hovering close to exactly 1. This would suggest that the business is not replacing old assets effectively.
All these ratios are very useful when measuring the performance of a business. Analysis can be conducted on many components of non-current assets to provide a lot of useful information into how the business is operating and managing its long-term assets.