Question

Assume you are interested in assessing how soon a company might need to make significant capital expenditures to replace property, plant, and equipment. What financial statement ratio would you use to help you make that assessment and why?

Answer 1

Financial statement ratio we would use to assess how soon a company might need to make significant capital expenditures to replace property, plant, and equipment is -

Accumulated depreciation to fixed assets ratio-

• Accumulated depreciation is a contra asset account that represents value lost on a fixed asset over time as it ages and become less useful.
• Fixed asset is a long-term tangible piece of property or equipment that a firm owns and uses in its operations to generate income. Fixed assets are not expected to be consumed or converted into cash within a year. Fixed assets most commonly appear on the balance sheet as property, plant, and equipment (PP&E).
• Accumulated Depreciation to Fixed Assets Ratio = Accumulated Depreciation / Fixed Assets

Reason of its use-

• The accumulated depreciation to fixed assets ratio is a financial measurement that calculates the age, value, and remaining usefulness of the property, plant, and equipments on a company’s balance sheet by comparing the total amount of depreciation taken on these assets with the total carrying cost. In other words, it what percentage of these assets have been used up.
• We can use this calculation to measure the productiveness of the company’s invested capital in fixed assets. A low ratio means that the assets have plenty of life left in them and should be able to used for years to come. A high ratio means the opposite.
• Depending on the type of asset and how long it has been owned, this may not be a bad number. If the company just purchased the assets last year, however, a 30% drop in value may seem concerning.

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