In his book Small Business Management, Michael Ames gives the following reasons for small business failure: Lack of experience, Insufficient capital (money) , Poor location, Poor inventory management, Over-investment in fixed assets, Poor credit arrangements, Personal use of business funds, and Unexpected growth .
This is the fourth in a series of eight posts concerning the top causes of small business failure. We will work our way up to the number one cause; however each one is an important issue for any small business to consider. This post is on over investment in fixed assets being a cause of failure.
Fixed asset turnover is the ratio of sales (on the Profit and loss account) to the value of fixed assets (on the balance sheet). It indicates how well the business is using its fixed assets to generate sales. A higher ratio is better because a high ratio indicates the business has less money tied up in fixed assets for each dollar of sales revenue. A lower or declining ratio may indicate that the business is over-invested in plant, equipment, or other fixed assets.
While some financial analysts claim that such a ratio is inconclusive and companies do not generally cite these figures, there has been an unfortunate trend in accounting curriculum across the nation to start to refrain from teaching the fixed asset turnover ratio. This ratio is especially important for startups and small businesses where access to capital is tighter than ever.
In today’s competitive business environment, the best place to start is with your performance relative to your peers. There is very little benchmarking data directly available like there is for inventory turnover however there is information that can be used to indirectly calculate benchmarking performance. For example, Return on Assets and Profitability data is directly available at
RetailOwner.com.
The following is a demonstration on how to indirectly benchmark yourself against industry peers. In this case, for a Gift Shop.
- Selecting Other Specialty Retail Stores from the dropdown menu of the Store Benchmarks tab at RetailOwner.com and then selecting Gift, Novelty, & Souvenir Stores shows a Return on Assets of 4.4% in 2009 and a Profit of 1.3% in 2009.
- The Profit divided by the Return on Assets provides the ratio of Total Assets to Sales or 29.5% in this case.
- With data for the percent of assets that are fixed, this benchmark can be converted to the Fixed Asset Turnover. This data can be found at bizstats.com. Clicking on the “Balance Sheet” tab brings up key ratios for Corporations and S-Corporations by industry. For example, clicking on S Corps and selecting Retail and then Miscellaneous Retail Stores for more detail information shows a percent of Fixed Assets of 16.78%.
- This brings the example’s Fixed Asset Turnover benchmark to 5.0%.
As a startup, it is likely you will have lower than average turnover (worse than average) because you are just beginning. The challenge is to look at your performance over time and determine how quickly you can be on par with your peers. If you are significantly different with no clear advantage, you may be over investing in fixed assets.
This is an opportunity to boot strap and locate deals or bargains – can you purchase used equipment, lease, or subcontract out work to minimize your exposure. Furthermore, considering building less capacity as businesses rarely fail because they are bursting at the seams – this is a nice problem to have and much easier to solve than the other way around.