The sales to fixed asset ratio is an asset utilization measure that allows analysts to understand if a company requires a large investment in property, plant, and equipment in order to generate revenues. Some industries are capital intensive, requiring significant assets to generate sales.
Investors oftentimes track this ratio over time, looking for a sudden increase in fixed assets followed by a jump in revenues. Ratios that are higher than the industry average are desirable.
Sales to Fixed Assets Ratio = Net Sales / Fixed Assets
Asset utilization measures allow investors to understand how well a company uses its assets in operations. Investors will typically track sales to fixed assets over time, looking for long term patterns in this metric. Companies with ratios that are higher than their industry average, or have ratios that increase over time, are desirable.
The sales to fixed assets ratio is typically a function of the capital intensity of an industry. For example, utilities require a relatively large investment in property, plant, and equipment to generate a given level of sales when compared to the software or financial services industries. For that reason, this metric is typically used when analyzing companies within a given industry.
Fixed assets are sometimes referred to as tangible assets, which include items such as land, buildings, machinery, and other equipment. Accounting standards dictate companies report property, plant, and equipment on the balance sheet at net book value. That is, historical cost less its associated depreciation. The sales used in this metric are net of returned items.
Whenever possible, the analyst-investor should avoid using a consolidated balance sheet if certain segments of a company are more capital intensive than others.
The transformer production equipment at Company A was approaching its theoretical capacity limit. The market for transformers was on the rise, and Company A's management team was evaluating the opportunity to increase the company's output of Type A transformers by 50%.
Currently, Company A's balance sheet reveals its total investments in fixed assets is $16,000,000, while its income statement indicates net sales of $20,000,000. This includes $5,000,000 in sales related to Type A transformers. Initial estimates reveal it would cost $2,500,000 in new equipment to increase capacity of these units by 50%.
The following table demonstrates the impact of this project on Company A's sales to fixed assets ratio:
|Increase in Sales ($5,000,000 x 0.50)||$2,500,000|
|Net Sales (Post Project)||$20,000,000||$22,500,000|
|Increase to Fixed Assets||$2,500,000|
|Fixed Assets (Post Project)||$16,000,000||$18,500,000|
|Sales to Fixed Assets Ratio||1.25:1||1.22:1|
Based on the analysis performed by Company A's management team, the project would have little impact on their sales to fixed asset ratio in the near term. As the net book value of the equipment decreases over time, the project should have a positive effect on this ratio.