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Accounting For Managers - Ratio Analysis

Fixed Assets Analysis

   Posted On :  27.01.2018 10:04 pm

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.

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