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Utilization of Property, plant, and equipment (PPE) in Financial Accounting

Utilization is measured by fixed asset turnover. To calculate fixed asset turnover, divide sales by the average book value of property, plant, and equipment. In 1997, OB’s sales were $395,196,000. Recall that book value equals historical cost less accumulated depreciation; it is also referred to as PPE - net. The average is calculated by adding beginning and ending PPE - net and dividing by two.

Fixed asset turnover reflects the number of sales dollars generated by a $1 investment in PPE. OB’s 1997 fixed asset turnover was 10.6:

Firms generally prefer a higher turnover. A low fixed asset turnover might suggest that property, plant, and equipment is being underutilized and that the firm might have excess capacity. On the other hand, a firm might elect the strategy of relying heavily on new, efficient, and costly equipment in the hope of reducing labor and other costs. This would reduce turnover and increase depreciation expense, but other cost savings will be realized. The extent to which a firm relies on leased assets can also affect turnover. Because some leased assets might not appear on balance sheets, firms using leased assets might have a smaller denominator and a correspondingly higher turnover.

Some additional factors might also affect fixed asset turnover. Accelerated depreciation methods reduce PPE - net more quickly than straight-line depreciation and result in a higher turnover ratio. Price changes and the maturity of a firm might also affect fixed asset turnover. As an example, let’s assume that fixed asset prices are increasing over time. New entrants into an industry will be forced to acquire their productive capacity at higher costs than firms that are already established. New entrants, therefore, would have a higher PPE - net and a lower turnover. In summary, although fixed asset turnover is intended to measure asset utilization, other factors such as those just described can also affect it.

Figure 6.4 - Selected Ratios

Figure 6.4 summarizes selected ratios for OB, Garan Inc. (one of OB’s competitors in the apparel industry), and, as a point of contrast, Birmingham Steel Corp. OB’s fixed asset turnover is nearly identical to that of its industry rival, Garan, suggesting that OB and Garan are equally successful in generating sales dollars from their investment in PPE. Also notice from figure 6.4 that the steel industry has a relatively low fixed asset turnover. This is because the steel industry is capital intensive. Greater amounts of property, plant, and equipment are needed to manufacture steel than to produce clothing.

Property, Plant, and Equipment (PPE) Topics

Related Noncurrent Assets Topics