What is fixed assets to net worth?
Fixed Assets to Net Worth Ratio is a debt financial ratio analysis. It is a system to shows in percentage terms the section of total assets of a company that is fixed up with fixed assets.
It is a simple calculation that tells us more about the solvency of a company.
It shows the scope to which the business funds are frozen in the form of fixed assets, such as property, plant, and equipment.
It indicates the segment of total assets that may not be utilized as working capital.
To understand the importance of this ratio, you need to first understand what fixed assets are.
A fixed asset is any asset that is not expected to be converted into cash in less than 1 year.
Buildings, furniture, machinery, delivery trucks, etc. are some good examples of a company’s fixed assets.
Details of fixed assets can be found under the Assets section of the balance sheet.
It’s difficult to use and compare this ratio. That is why we prefer to use a similar ratio “Non-current assets to net worth” implicating IFRS term “Non-current assets”.
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Advantage fixed assets to net worth
- This ratio is indicative of the power of the solvency of an organization.
- It indicates the liquidity level of the company.
- It shows the current debt obligations of an organization.
- Shows the financial health of the company.
Disadvantage fixed assets to net worth
- It should be noted that the fixed-assets to total net worth ratio should neither be very high nor very low.
- Too high a value indicates low solvency level and too low a value indicates that the firm has insufficient fixed assets for continued operations.
- Any mistake while calculating the net worth of a firm is dangerous.
- Intangible assets such as goodwill and intellectual property are not counted in the total asset calculation.
- It is very difficult to assign a value to intangible assets and thus lenders usually care only about the tangible assets.
- Just like any other ratios, this ratio alone does not show a complete picture of the firm’s financial position.
Analysis of an Interpretation of fixed assets to net worth
A value higher than 0.75 (optimal ratio may vary depending on the industry and the specific circumstances in which the firm is operating) signifies that the firm is investing excessively in non-liquid assets.
It could mean that there is too little cash left for the day to day operations of the firm.
A firm having such a high ratio might not be prepared to handle any unexpected events that affect their business.
A high value could also mean that the firm is not able to efficiently utilize its fixed assets.
Higher the proportion of assets that are liquid, lesser the amount available for the company’s other operations, and working capital. So what is a good fixed asset to net worth ratio?
Simply, ideally, you should look for companies with the fixed assets to net worth ratio of 0.50 or lower.
As mentioned earlier, there’s no standard value for this ratio. However, as an investor, you had better avoid investing in less liquid companies.
It’s worth spending some time comparing the net fixed assets to total net worth ratio of a company with that of its competitors and the industry averages.
By doing so, you can easily determine how your company’s utilizing its fixed assets; thereby you can make a better investment decision.
Comparing this ratio against industry-average ratios can tell you whether your ratio is better or worse than your competitors.
The high value of this ratio may be raised as liquidity problems, for the reason that it means the company does not have immediate access to cash.
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Formula Calculation
Fixed-assets-to-net-worth ratio can be calculated by dividing the value of all fixed assets by net worth.
Fixed assets refer to the long-term, tangible business assets that are classified as property, plant, and equipment. Subtracting total liabilities from total assets yields the net worth.
Multiplying the resulting ratio by 100 expresses it in percentage terms.
The formula for calculating a company’s net fixed assets to net worth ratio looks like this:
To calculate net fixed assets, you will take the value of total fixed assets and deduct the accumulated depreciation from it.
The net worth of the firm is what will be left if the firm decides to shut shop and pay off all its liabilities.
It’s worth noting that we do not include intangible assets while calculating total assets in the net worth calculation.
That’s because, even though intangible assets are still assets, but they are in physical in nature, or in other words, they cannot be seen or tough, as well as they are not easily converted into cash.
So instead of using the regular net worth of a company in your valuation, you can go ahead and exclude the intangible assets from that company’s total net worth like so:
Tangible Net Worth = Total assets – Total Liabilities – Intangible Assets
These figures are all reported on a company’s balance sheet.
Example
In order to help you understand clearly how to find this ratio, let’s consider a quick example.
For example, you can be investing in Company XYZ that has $650,000 in fixed assets. The firm claimed $85,000 in depreciation on the machinery in each of the last two years.
After looking into its financial statements, you found that it has $600,000 in total assets, $65,000 in intangible assets, and $125,000 in total liabilities.
So how do we find this company’s fixed-assets to net worth ratio?
First of all, you will need to calculate its net fixed assets, like so:
Net Fixed Assets = Total Fixed Assets – Accumulated Depreciation
Net Fixed Assets = $650000 – 2 * $85000 = $ 480000 (Depreciation for 2 years of $85000)
Then, you can find the company’s tangible net worth by subtracting the intangible assets and total liabilities from its total assets, like this:
Net Fixed Assets = Total Fixed Assets – Accumulated Depreciation
Net Fixed Assets = $600000 – $125000 – $65000 = $600000 – $190000 = $410000
By using the given formula, you can easily arrive at Company XYZ’s net fixed assets to tangible net worth ratio of 1.17, as follows:
Fixed-Assets to Net Worth Ratio = Net Fixed Assets / Tangible Net Worth
Fixed-Assets to Net Worth Ratio = $480000/$410000= 1.7
The ratio value of 1.17 indicates that the company’s net fixed assets value is outweighing its tangible net worth.
That’s to say, this company relies too much on low liquid assets, and it may face difficulty when converting these assets into cash when needed.
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