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Subject 5. Using Disclosures in Analysis PDF Download

Ratios used in analyzing fixed assets include the fixed asset turnover ratio and several asset age ratios.

Fixed Asset Turnover Ratio

Fixed asset turnover is a measure of a company's utilization of fixed assets.

net assets = gross fixed assets - depreciation on fixed assets.

This ratio should be compared to the industry norm. The impact of leased assets should be considered, particularly for industries such as retail and airlines that lease most of their fixed assets.

Accounting choices do affect ratios. Analysts must always be aware of accounting choices and how they affect the calculation of ratios. If a company leases most of its assets and they are classified as operating leases, which means they are not recorded on the balance sheet, then the company will have fewer assets and therefore a higher turnover ratio.

If a company writes down assets due to impairment, in the years following the write-down, assets will be lower and the turnover ratio higher.

The range of the asset turnover values should be consistent with the industry.

An abnormally high turnover ratio indicates that a company does not have enough capacity to meet potential demand or that the company may have obsolete equipment. Therefore, age of assets also affects this ratio. A higher ratio, caused by old assets, might look positive on the surface, but it would also imply the need for capital expenditures in the near future. Analysts must consider other factors (like age of assets) when considering which company is in a better position for the future. Age of assets is viewed as a factor by analysts because older assets imply the need for future cash outflows to replace assets. The ratio might look better for a company with older assets but the company is actually in a less favorable position than a comparable company that has replaced its assets and is using more efficient assets.

An abnormally low turnover ratio indicates that too much capital is tied up in excess assets relative to the needs of the company.

Asset Age Ratios

Companies may choose different depreciation methods (e.g., a straight-line method or an accelerated method) and accounting estimates (e.g., salvage value or useful life) related to depreciation. Disclosures required for depreciation often do not facilitate specific adjustments. Analysts may evaluate the relationships between various depreciation-related items (e.g., gross PPE, accumulated depreciation, depreciation expense, cash flows for capital expenditure, and asset disposals).

  • Relative Age (in %) = Accumulated Depreciation / Ending Gross Investment. This equation suggests how much of the useful life of the company's overall asset base has passed.

  • Average Depreciable Life = Ending Gross Investment / Depreciation Expense.

  • Average Age (in years) = Accumulated Depreciation / Depreciation Expense. This equation indicates how many years' worth of depreciation expense has already been recognized.

More ratios:

  • The ratio of Net PPE / Depreciation Expense suggests how many years of useful life remain for a company's overall long-term asset base.
  • CapEx / (Gross PPE + CapEx) signifies what percentage of the asset base is being renewed through new capital investment.
  • CapEx / Asset Disposal indicates the growth of the asset base.

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