Financial Ratio: Operating Ratios (Part 1)

Easy steps to get Fixed Asset Turnover Ratio and Working Capital Turnover Ratio

Hi, and welcome to the second part of our series on financial ratio analysis. Just to get you up to speed, here’s what we are up to:

When considering investments or trades, there are generally two approaches used by people to analyze their prospects. These approaches are known as technical analysis and fundamental analysis.

Each approach utilizes different methods to evaluate the worthiness of companies for investment. In this case, we will focus on the fundamental investors, also known as value investors, and their way of evaluating investments.

In a nutshell, fundamental investors seek to identify the intrinsic value of a company. They do this by examining the financial statements of the company, including the Profit & Loss Statement, Balance Sheet, and Cash Flow Statement. You can click on the hyperlinks provided for a comprehensive guide on how to read these statements.

How do they examine all the financial statements above? By using financial ratios! If you want a general overview of how financial ratios work, check out this article — Fundamental: Introduction to Financial Ratios. There are four branches of financial ratios available: Profitability, Operating, Leverage, and Valuation.

Please also look at the chart below to get a full picture of where we are.

So, we are in the “Operating Ratio” category while the types of ratios that we are going to discuss for now are the Fixed Asset Turnover Ratio and Working Capital Turnover Ratio. Let’s go!

Fixed Asset Turnover

This ratio measures a company’s ability to generate revenue from its fixed assets, such as property, plant, and equipment. It indicates how efficiently a company is using its fixed assets to generate sales. Simply, it tells you if the company knows what machine to use to make the most money.

To put it into perspective, if a company has a Fixed Asset Turnover ratio of 2, it means that for every dollar invested in fixed assets, the company generates $2 in sales. If another company has a Fixed Asset Turnover ratio of 1, it means that for every dollar invested in fixed assets, the company generates $1 in sales.

How to calculate Fixed Asset Turnover?

The formula is as follows:

Fixed Asset Turnover = Operating revenues / Average Fixed Asset

Now, how to find all that?

Before we start, for this example we’ll look at Apple’s 2022 Financial Statement that you can download here.

Per below, we can find in Apple’s statement of operations that they made $394,328 million in sales. Mind you, the number refers to the fresh sweet money they got, without considering how much cost they used, tax, and all of that yet. The money is so freshly caught, they’re still wriggling!

As for its average fixed asset, we’ll sum up its fixed assets for 2022 and 2021, and then divide it by the two years. We can find the required values in Apple’s Balance Sheet.

Average Fixed Asset = [42,117 + 39,440] / 2

Average Fixed Asset = 40,778.5

Now that we have all of them, let’s put them into our formula:

Fixed Asset Turnover = Operating revenues / Average Fixed Asset

Fixed Asset Turnover = 394,328 / 40,778.5

Fixed Asset Turnover = 9.67

So, for every $1 that Apple spends in its 2022 Financial Year (up until September), they make $9.67!

Working Capital Turnover

Working Capital Turnover is a financial ratio that measures a company’s ability to generate revenue relative to its working capital, which is the amount of money a company has available to finance its day-to-day operations.

A relatively high ratio could indicate that a company is able to turn over its working capital quickly and efficiently, while a low ratio could suggest that the company is experiencing operational inefficiencies that are negatively impacting its ability to generate revenue.

How to calculate Working Capital Turnover?

The formula is as follows:

Working Capital Turnover = [Revenue / Average Working Capital]

Where:

Working Capital = Current Assets — Current Liabilities

As for Apple, its revenue is $394,328 million per mentioned in its Statement of Operations.

As for its Average Working Capital, we’ll have to look for its Working Capital first.

For 2021, its working capital is:

134,836–125,481 = 9,355

For 2022, its working capital is:

135,405–153,982 = -18,557

Now, the Average Working Capital is:

9,355 + (-18,557) = -9,222

With its Revenue and Average Working Capital available, let’s get down to our formula:

Working Capital Turnover = [Revenue / Average Working Capital]

Working Capital Turnover = 394,328/-9,222

Working Capital Turnover = -42.76

Well, you can say that Apple is not sufficiently using its available working capital, and they would either borrow more money or generate more sales to satisfy their current obligations.

Another thing to note on both of the ratios mentioned above is that you will have to compare a company’s ratio with its peers; and one ratio is never enough for you to decide if a company is a good buy or not.

Bottom line

Fixed Asset Turnover Ratio indicates how efficiently a company is using its fixed assets to generate sales.
Working Capital Turnover Ratio is used to evaluate a company’s ability to manage its working capital effectively and generate revenue from its operating activities.
One must compare the ratios of a company with a company’s peers to truly understand if the ratio indicates a good or a bad sign.
A ratio that looks bad isn’t always a sign of a bad company. Look at other ratios as well to get a full perspective of the company.
Some of the terms above are used differently by companies, but if you understand what the numbers essentially represent, you’ll know which is which.

Do keep an eye out for our posts by subscribing to our channel and social media.

None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.

Written By

Become a AXEHEDGE investor today.

ascending