11/16/2023 0 Comments Total asset turnover ratio![]() ![]() The chart below provides examples of capital-intensive and non-capital-intensive industries. If so, companies with a lower capital intensity ratio are most likely more profitable with more free cash flow (FCF) generation since more revenue can be generated with fewer assets.īut to reiterate, an in-depth evaluation of the companies’ unit economics is necessary to confirm if the company is, in fact, more efficient. ![]() Hence, comparing the capital intensity ratio of different companies should only be done if the peer companies operate in the same (or similar) industry. There is no set rule on whether a high or lower capital intensity ratio is better, as the answer depends on the circumstantial details.įor example, a company with a high capital intensity ratio could be suffering from low-profit margins, which are the byproduct of inefficient utilization of its asset base - or the general line of business and industry could just be more capital intensive. sum of the beginning of period and end of period balance, divided by two). The formula for calculating the total asset turnover is the annual revenue divided by the average total assets (i.e. The total asset turnover measures the amount of revenue generated per dollar of assets owned. The capital intensity ratio and total asset turnover can be calculated using only two variables: The capital intensity ratio and asset turnover are closely related tools for gauging how efficiently a company can utilize its asset base. The 0.5x capital intensity ratio implies that the company spent $0.50 to generate $1.00 of revenue.Ĭapital Intensity Ratio vs. Capital Intensity Ratio = $500,000 ÷ $1 million = 0.5x.If the company’s total asset balance was $450,000 in Year 0 and $550,000 in Year 1, the total average assets balance is $500,000.įrom the equation below, we can see that the capital intensity ratio comes out to 0.5x. Suppose that a company has $1 million in revenue during Year 1. Capital Intensity Ratio Calculation Example The formula for calculating the capital intensity ratio consists of dividing the average total assets of a company by its revenue in the corresponding period. Simply put, the capital intensity ratio is the amount of spending required per dollar of revenue generated. One method to gauge a company’s capital intensity is called the “capital intensity ratio.” Learn More → Hedge Fund Primer Capital Intensity Ratio Formula On the other hand, a decrease in an operating NWC asset and an increase in an operating NWC liability causes free cash flows (FCFs) to rise. accounts payable, accrued expenses) reduces free cash flows (FCFs). accounts receivable, inventories) and a decrease in an operating NWC liability (e.g. Why? An increase in an operating NWC asset (e.g. Negative Change in NWC → More Free Cash Flow (FCF).Positive Change in NWC → Less Free Cash Flow (FCF).Net working capital (NWC), the other type of reinvestment besides CapEx, determines the amount of cash tied up in day-to-day operations. property, plant & equipment (PP&E), while depreciation is the allocation of the expenditure across the useful life assumption of the fixed asset. Learn More → Hedge Fund Primer What is a Good Capital Intensity Ratio?Ĭapital intensity is a key driver in corporate valuation because numerous variables are impacted, namely capital expenditures (Capex), depreciation, and net working capital (NWC).Ĭapex is the purchase of long-term fixed assets, i.e. requiring consistently high capital expenditures (Capex) as a percentage of revenue. If a company is described as “capital intensive,” its growth is implied to require substantial capital investments, whereas “non-capital-intensive” companies require less spending to create the same amount of revenue.Ĭommon examples of capital assets can be found below:Ĭompanies with significant fixed asset purchases are considered more capital intensive, i.e. how much capital is needed to generate $1.00 of revenue. How to Calculate the Capital Intensity Ratio?Ĭapital-intensive industries are characterized by substantial spending requirements on fixed assets relative to total revenue.Ĭapital intensity measures the amount of spending on assets necessary to support a certain level of revenue, i.e. The Capital Intensity Ratio describes a company’s level of reliance on asset purchases in order to sustain a certain level of growth. ![]()
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