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Measuring Property, Plant & Equipment Asset Efficiency

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  • 0:05 Measuring Equipment Efficiency
  • 0:27 Calculating Asset…
  • 2:40 Improving Efficiency
  • 3:21 Lesson Summary
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

A typical company spends a great deal of money on property, plant, and equipment assets. Calculating the asset turnover ratio helps companies determine if their assets are being used efficiently.

Measuring Equipment Efficiency

Urban Sneaks is a shoe company that's been in business for 30 years, enjoys considerable success and is known for a high-quality product. Some of Urban Sneaks' equipment is getting quite old, and the owner of the company, Ms. B. Shue, is wondering if it's time to replace it. She needs a way to measure how efficient her equipment is in making money for her business.

Calculating Asset Turnover Ratio

Since resources are finite, it is important for every business to use its assets (items that it owns) as efficiently as possible. Property, plant, and equipment assets are defined as large items (like machinery, equipment, and buildings) that a company uses to generate sales revenue. Since property, plant and equipment assets usually represent a significant monetary investment for any company, it's important to determine whether or not the company is using these assets in an efficient manner to produce sales.

The best way to measure the efficiency with which a company is using its property, plant, and equipment assets is to calculate the asset turnover ratio. The formula for the asset turnover ratio is net sales divided by average property, plant, and equipment assets.

Let's assume that the Urban Sneaks Company had property, plant, and equipment assets of $500,000 last year and $650,000 this year, with net sales of $2,500,000 in the current year. The asset turnover ratio would be 4.35: $2,500,000 / (($500,000 + $650,000) / 2). A ratio of 4.35 means that the company generates $4.35 of sales for each dollar that it spends on property, plant, and equipment assets. Generally, the higher the ratio, the more efficiently the company is using its property, plant, and equipment assets to generate sales revenue.

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