Fixed Asset Ratios
What are Fixed Asset Ratios?
Fixed asset ratios analyze the performance of a company relative to its asset base. Here are four commonly used asset ratios:
- Fixed asset turnover
- Capex ratio
- Average age of PP&E
- Reinvestment ratio
All these ratios must be analyzed in comparison to industry competitors.
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.
Fixed assets need to be replenished and will increase in a growing company. It is important for companies to invest in their asset base to maintain business operations and growth.
Key Learning Points
- Four commonly used asset ratios are: Fixed asset turnover, Capex ratio, the average age of PP&E, and the reinvestment ratio
- Fixed asset turnover measures the efficiency of PP&E in generating sales. A higher fixed asset turnover indicates greater efficiency in generating sales from fixed assets.
- The Capex ratio measures investments relative to company sales. An increase in this ratio over time may suggest future growth.
- The average age ratio appraises the age of the asset base (in this case PP&E) and shows the average age of assets. A high ratio suggests the business has an “ageing asset base”
- The reinvestment ratio (sometimes referred to as the replenishment ratio) compares capex to depreciation. It indicates whether depreciating assets are being replaced.
Fixed Asset Ratios – Explained
Fixed Asset Turnover
This ratio measures the efficiency of a company’s PP&E in generating sales. It assesses whether a company is investing wisely in its assets. A high asset turnover ratio indicates greater efficiency to generate sales from fixed assets. Analysts should keep an eye on any significant asset purchases or disposals during a year as these can impact the asset turnover ratio. The ideal asset turnover ratio varies by industry. The ratio is lower for asset-intensive industries such as telecommunications or utilities.
Fixed Asset Turnover = Sales / Net fixed assets
The capex ratio measures investments in PP&E 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 future. This pattern of continuous reinvestment of retained earnings year after year is what drives company growth and
Capex Ratio = Capital expenditures / Sales
Average Age of 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.
Average Age Ratio = Accumulated depreciation / Gross PP&E
The reinvestment ratio (sometimes referred to as the replenishment ratio) compares Capex to depreciation. It is an indicator of what level of investment is being made into assets. In other words, are depreciating assets being replaced? This ratio is expressed as a multiple and a healthy business should expect this multiple to be greater than 1. Due to inflation, assets purchased many years ago will cost more to replace than if purchased today. Depreciation is calculated at historical costs so should be a cause for concern if this ratio was hovering close to 1. This would suggest that the business is not replacing old assets.
Average Age Ratio = Capital Expenditure / Depreciation
Asset Ratios Example
We can better understand asset ratios using information from two companies with similar sales but differences in asset-related figures. Both companies operate in similar industries making comparisons reasonable.
Company A has a higher fixed asset turnover ratio than Company B. This indicates that for every $1.00 spent on fixed assets, it generates higher sales (0.5 against 0.45). It also has a higher Capex ratio than Company B, indicating higher potential future growth. It also has a lower average age of PP&E. This indicates a comparatively lower “ageing asset base” against Company B. Company A also has a higher reinvestment ratio indicating the business is replacing its old assets effectively. Company B’s reinvestment ratio of less than 1 is worrisome. Ideally, the capex is higher than the depreciation expense to replenish old assets.