What is Net Fixed Assets?
The Net fixed asset is the calculation made for knowing the assets’ residual value. It calculates theoretically the remaining life for which the asset can be used and its remaining value using the total price amount paid at the time of purchase minus the depreciation amount already taken since the time asset was purchased.
- If the accumulated depreciation of the asset is huge, it means that the age of the asset is high and the company has not replaced its assets from a long time. This metric is more useful for the investors as it gives the idea to them that at that time in a future company is going to make a huge investment in the purchase of assets.
- Along with this it also helps investors in knowing how efficient the management of the company is in using its assets. This metric is more useful at the time of mergers and acquisitions because if the company is analyzing the different possible acquisition candidates then, in that case, they must analyze assets value as on the basis of that only they can put a value on them.
- If the net fixed asset amount is low when compared with the total fixed assets value then it shows that huge amount will be needed in future for replacing the assets and the acquiring company can value the assets considering this in mind.
Components of Net Fixed Assets
#1 – Fixed Assets
Fixed assets are the assets which an enterprise purchase for the long term use and are not meant for the purpose of sale, unlike stock. These assets are not readily converted into cash and are utilized for generating revenue. Fixed assets are of two types
- Tangible assets (that can be touched) such as building, plant & machinery, equipment, furniture, etc.
- Intangible assets (that cannot be touched) such as goodwill, patent, trademark etc.
#2 – Accumulated Depreciation
The cumulative depreciation charged on an asset from the date of its starting of use till the present date of use is the accumulated depreciation. Each year the depreciation is charged on the asset and that is then added to accumulated depreciation account. For example, On 1st April 2016 Furniture worth $100,000 was purchased. The useful life of plant & machinery is 15 years and say its residual value is 10% of the cost of the asset. So depreciation for the financial year 2016-17 is ($100,000 – 10% of $100,000)/15 = $6000.
Similarly, for the financial year 2017-18 and 2018-19, the depreciation charged is $6,000 each year. Therefore, the accumulated depreciation as on 31st March 2019 is:
$6,000 + $6,000 + $6,000 = $18,000 i.e. the cumulative depreciation from its date of put to use till the present date.
#3 – Capital Improvements
Improvements are the capital additions on the fixed assets which are done to increase the efficiency and capacity of the asset resulting in an increase in its operational efficiency. The depreciation is charged on the capital improvements over its useful life.
#4 – Fixed Assets Liabilities
Liabilities that are associated with fixed assets are fixed assets liabilities that includes all the debts which arise due to the purchase or improvements of fixed assets and the company is required to pay the same to the outsiders.
Net Fixed Assets Formula
When all the impairments and accumulated depreciation are deducted from the fixed assets’ purchase price and cost of improvement then the amount we get is net fixed assets amount. In equation form:
Basic Equation of Net Fixed Assets Formula
Net Fixed Assets Formula = Gross Fixed Assets – Accumulated Depreciation
This is the basic form of the equation. The fixed assets include tangible assets mostly such as plant & machinery, building, equipment, furniture etc. Accumulated depreciation is the total amount of depreciation expense that has been charged to profit and loss account from the date of purchase of the fixed asset.
Many analysts think that the Net Fixed Assets formula is needed to be taken a step forward. So, besides accumulated depreciation, they remove fixed assets liabilities also from the fixed assets and the improvement cost.
The above sentence can be represented in a net assets formula which is as follows:
Net Fixed Assets Formula= (Total Fixed Asset Purchase Price + capital improvements) – (Accumulated Depreciation + Fixed Asset Liabilities)
The liabilities related to fixed assets are removed to know the actual net assets that the company owns.
Liabilities are the financial obligations and the combined debts that the company is obliged to pay to the outsiders.
Example of Net Fixed Assets Formula
Let’s take the example of a company named Shanghai automobiles who wants to expand its operations. For that, the company is planning to buy another company named apex automobile having its operations in another territory.
So Shanghai automobiles want to decide whether they should buy apex automobile or not. So for that Shanghai automobiles wants to ensure that the assets of the apex automobile are in good condition. If the assets came out to be in good condition then the shanghai automobiles are not required to buy new assets for the furtherance of business.
The balance sheet of apex automobiles reported the following figures in the balance sheet:
- Sum of all fixed assets: $3,000,000
- Accumulated depreciation: $700,000
- Capital Improvements: $600,000
- Total liabilities on fixed assets: $380,000
Therefore, the net fixed assets of Apex ltd are:
Net fixed assets Formula = ($3,000,000 + $600,000) – ($700,000 + $380,000) = $2,520,000
Now for the analysis, we need to calculate net fixed assets ratio which is as follows:
Net Fixed Assets Ratio formula = Net Fixed Assets/ (fixed Assets +Capital Improvements)
=$2,520,000 / $3,600,000 = .70
This ratio analysis shows that the apex automobile has depreciated its assets to the extent of 30% of the total cost and the improvements of the fixed assets. This shows that the assets are not that old and can be used for the large duration in the future.
Advantages of Net Fixed Assets
- The net fixed asset information in any company helps the stakeholders of the company in knowing the financial reporting, financial analysis, and business valuation. It is helpful in determining the financial health of the company
- It is helpful for the analysts to know how the numbers are determined as by using the metric they can know what method was used by the company because there are multiple accepted methods for the recording assets, depreciating assets, and disposing of assets
- Fixed assets analysis is very important in capital-intensive industries because these industries require huge investments in Plant, Property & Equipment. When there are net negative cash flows because of the purchase of the fixed assets then it is the indicator that the firm is in growing mode.
Disadvantages/Limitations of Net Fixed Assets
- Use of Net Fixed Assets will be meaningless if there is accelerated depreciation. For example, equipment is purchased by the company and in the same year, it claims full depreciation of entire purchase as per any section which allows full depreciation in the same year. So, in that case, the new equipment will have zero net book value which may lead to wrong interpretation.
- If the asset is already depreciated fully does not means that the asset is necessarily worthless. Many assets are there, the life of which is less but they prove useful for even 3-5 times over the expected life.
- Before making any conclusion, one should look at differences between values as per tax and value as per the book because accelerated depreciation schedules mostly are acceptable for the tax purposes but the same is not allowed by the GAAP.
Many of the entrepreneurs don’t have the clear idea of the worth of the asset their company is holding which at a later stage can prove costly to them as it is always good to know the worth of company so that future decisions can be taken accordingly. In this context, Net Fixed Assets becomes very important.
This has been a guide to Net Fixed Assets. Here we discuss how to calculate Net Fixed Assets using its formula along with practical examples. You may learn more about accounting from the following articles –