Fact: any business needs to invest in fixed assets to achieve its goals. Whether it’s manufacturing equipment or office furniture, no one can run a smooth operation without them.
Also a fact: most, if not all, of these essential assets require a large investment.
And another fact: despite their premium price, fixed assets will invariably depreciate and lose value over time.
So the question is, how can you be sure you’re making the most of each of these investments? First, don’t wait around for a sprinkle of fairy dust! As usual, you need KPIs to keep things in control and track return on investment.
There are two main KPIs to assess the returns you’re getting from your investments: RoFA and FAT (or FATR). So let’s look at what this means, how to calculate RoFA, how to calculate FAT, and how to improve return on fixed assets.
Quick recap: what is a fixed asset?
Let’s brush up on your accounting skills. A fixed asset is any tangible asset the company plans to use for over a year. For example, buildings, land, machinery, vehicles, tools, furniture, computers, and so on. Long-term assets vital to a company’s operations are also known as Property, Plant, and Equipment (PP&E).
All of these fixed, tangible assets lose value over time due to wear and tear, which is known as depreciation. There are several ways to calculate depreciation, including straight line depreciation, which we’ve already covered. Generally, depreciation is a good indicator of how an investment spreads over time.
What is RoFA?
RoFA stands for Return on Fixed Assets, or how much money the company makes in return for its assets. To calculate RoFA, divide current operational income by investment cost.
How to calculate RoFA
Imagine a company sells £5 million worth of goods, but has spent £20 million on machinery. From the RoFA formula, we have:
But what does RoFA mean? In practical terms, it means the company is getting £0.25p for every £1 spent. Therefore, it’s safe to say RoFA is a good indicator of both return on investment and profitability.
There isn’t a standard you should strive for when it comes to RoFA. For example, industries that are capital-intensive, and require a huge amount of fixed assets, have a lower RoFA. However, their return on fixed assets should improve over time, as income grows. More than trying to hit a standard, monitor the direction in which RoFA is going.
What is FAT or FATR?
FAT or FATR means Fixed Asset Turnover Ratio, and it measures how much the company uses its assets. To calculate FAT, divide net sales by the average fixed assets.
How to Calculate Fixed Asset Turnover
Imagine a company sells £5 million worth of goods. In the beginning of the year, its assets’ beginning balance was £2m. In the end, it was £1.9m.
Fixed assets turnover ratio can also be calculated by taking into account asset depreciation. In that case, the formula for fixed asset turnover would be:
This means the company earns approximately £2.56 per £1 spent on assets. Note that FAT is not an indicator of profitability or cash flow. What it shows is how well a company uses the assets it already has. A higher ratio means you’re using assets more effectively, but there isn’t a global benchmark.
How to Improve Return on Fixed Assets
The obvious way to get more return on fixed assets is to extend their useful life, and this is where maintenance really shines. If you manage to keep assets in optimal condition through routine maintenance, production never halts, machines last longer, and therefore you get more return on investment. Plus, you’ll avoid excessive spending on emergency maintenance and losses due to disruptions and downtime.
How you go about it is another question entirely. Proponents of Total Productive Maintenance believe that every worker should play their part, while other managers prefer to invest in increasingly more sophisticated predictive maintenance techniques. In any case, it’s generally wiser to be proactive than reactive.
Maintenance and Repairs Expense to Fixed Assets Ratio
If you’re thinking maintenance will eat a big portion of your budget, you should monitor the maintenance and repair expenses to fixed assets ratio. Here’s the formula:
Where total fixed assets equals the cost of assets, and not their value after depreciation. If this ratio goes up, it means your fixed assets are becoming more expensive to upkeep. The lowest the ratio, the better, and anything under 10% is very good. (Unless, of course, you’re not performing due maintenance – in which case you’ll also have a low fixed asset turnover ratio).
A high ratio means your fixed assets may be too worn out and not be worth the costs. So, like depreciation, it’s a good indicator of whether you need to replace a fixed asset or not.
The big takeaways
We started by stating three facts: companies need fixed assets, fixed assets require investments, and companies need to make the most of those investments. Return on fixed assets (RoFA) and Fixed Asset Turnover Ratio (FAT) are two indicators that help you assess return on investment. RoFA is a good indicator of profitability, while FAT shows how effectively you’re using current company assets.
There aren’t any benchmarks for any of these indicators, but you should monitor whether they increase or not. The best way to improve them is to ensure asset availability and reliability, which you can achieve through timely and preventive maintenance. Which is not to say every maintenance and repair expense is justified; if the maintenance to fixed asset ratio increases, it’s probably time to replace equipment.