Accounting For Managers - Ratio Analysis
Fixed Assets Analysis
The successful operation of a business generally requires some assets of fixed character. These assets are used primarily in producing goods and in operating the business. With the help of these, raw materials are converted into finished products. Fixed assets are not meant for sale and are kept as a rule permanently in the business in order to carry on day-to-day operations.
Analysis
of fixed assets is very important from investors’ point of view because
investors are more concerned with long term assets. Fixed assets are properties
of non-current nature which are acquired to provide facilities to carry on
business. They include land, building, equipment, furniture, etc. They are
generally shown in balance sheet by aggregating them into groups of gross block
as reduced by the accumulated amount of depreciation till date. Investment in
fixed assets is of a permanent nature and therefore should be financed by
owners’ funds (permanent sources of funds). The owners’ funds should be
sufficient to provide for fixed assets. Fixed assets are generally financed by
owners’ equity and long-term borrowings. The long-term borrowings are in the
form of long-term loans and of almost permanent nature. Under such a situation
it becomes more or less irrelevant to relate the fixed assets with only the
owners’ equity. Therefore, the analysis of the source of financing of fixed
assets has been done with the help of the following ratios:-
(a)
Fixed
Assets To Net Worth
(b)
Fixed
Assets To Long-Term Funds Fixed Assets To Net Worth: in the
words of anil b.roy choudhary, “this ratio indicates the relationship between
net worth (i.e. Shareholders’ funds) and investments in net fixed assets (i.e.
Gross block minus depreciation)”.
The
higher the ratio the lesser would be the protection to creditors. If the ratio
is less than 1, it indicates that the net worth exceeds fixed assets. It will
further indicate that the working capital is partly financed by shareholders’
funds. If the ratio exceeds 1, it would mean that part of the fixed assets has
been provided by creditors. The formula for derivation of this ratio is:-
Net
Fixed Assets
Fixed Assets To Net Worth Ratio = ------------------
Net
Worth
Fixed
Assets To Long-Term Funds: this ratio establishes the relationship
Between
the fixed assets and long-term funds and it is obtained by the formula:
Fixed
Assets
FIXED ASSET RATIO = --------------------
Long-Term
Funds
The ratio
should be less than one. If it is less than one, it shows that a part of the
working capital has been financed through long-term funds. This is desirable
because a part of working capital termed as “core working capital” is more or
less of a fixed nature. The ideal ratio is 0.67.
If this
ratio is more than one, it indicates that a part of current liability is
invested in long-term assets. This is a dangerous position. Fixed assets
include “net fixed assets” i.e. Original cost less depreciation to date and
trade investments including shares in subsidiaries. Long-term funds include
share capital, reserves and long-term borrowings.
