Fixed asset

Definition

A fixed asset, also known as a tangible or non-current asset, refers to a long-term, physical asset held by a company for use in its operations and not intended for sale in the normal course of business.

What are fixed assets?

Fixed assets are vital for a company’s day-to-day operations and are not expected to be converted into cash within one year. 

Examples of fixed assets:

1. Property, plant, and equipment (PPE): This category includes buildings, land, machinery, vehicles, and other physical assets used in the production process.
2. Furniture and fixtures: Items like office furniture, fixtures, and equipment that are necessary for business operations.
3. Intangible assets (in some cases): Some are classified as fixed assets if they have a finite useful life and meet specific accounting criteria. 

Fixed assets play a direct or indirect role in revenue generation. For instance, machinery in a manufacturing plant directly contributes to production, while an office building indirectly supports the organisation’s operations.

Fixed assets are subject to depreciation, which is the systematic allocation of their cost over their estimated useful life. This process reflects the gradual wear and tear or obsolescence of the asset.

Fixed assets are a significant component of a company’s financial position and are disclosed in the balance sheet. The accurate valuation and proper accounting of fixed assets are crucial for financial reporting and analysis.

Calculation of fixed assets

The calculation of fixed assets involves determining their net book value on the balance sheet. To do so, use this formula:

Net book value = Initial costs – Accumulated depreciation

Where the initial costs record the original purchase price of the asset, including all costs necessary to get it ready for use and accumulated depreciation calculates the total depreciation expense that has been recorded over the asset’s useful life using an appropriate depreciation method. This net book value represents the current accounting value of the fixed asset.

Fixed assets vs. current assets

Fixed assets and current assets are two categories of a company’s assets. Fixed assets, such as property, plant, and equipment, are long-term investments used in operations and not easily converted to cash within a year. They are subject to depreciation over time. Current assets, on the other hand, include cash, inventory, and accounts receivable, which are expected to be converted to cash or used up within one year. While fixed assets support long-term business operations, current assets are crucial for managing short-term liquidity and operational needs.

Fixed asset turnover ratio

The fixed asset turnover ratio measures a company’s efficiency in generating sales from its fixed assets. It is calculated by dividing net sales by the net book value of fixed assets. The formula is:

Fixed asset turnover ratio = Net sales / Net fixed assets

A higher ratio indicates better utilisation of fixed assets in generating revenue, suggesting effective management of investments in property, plant, and equipment. Conversely, a lower ratio may indicate underutilisation of fixed assets. This ratio is particularly useful for capital-intensive industries, where significant investments in fixed assets are necessary for operations.

Example of fixed assets

Company ABC, a manufacturing company, has the following fixed assets on its balance sheet as of December 31:

1. Land: £500,000 – The land on which the company’s manufacturing facility is situated.
2. Buildings: £2,000,000 – The manufacturing plant and office buildings owned by the company.
3. Machinery: £1,200,000 – Specialised machinery used in the production process.
4. Vehicles: £300,000 – Delivery trucks and other vehicles used for transportation.

The total value of fixed assets on Company ABC’s balance sheet is £4,000,000.