What is the Equipment Freshness Coefficient?

The equipment freshness coefficient refers to the ratio of the net value of a company's fixed assets (equipment) to the original value of its fixed assets (equipment). The net value of fixed assets refers to their original value minus the accumulated depreciation expenses deducted annually. Clearly, for a piece of equipment with a fixed original value, the longer it is used, the more depreciation is accumulated annually, and the lower its net value becomes. Therefore, the level of a company's equipment freshness coefficient directly reflects the age and condition of all its equipment.

 

Formula for Calculating the Equipment Freshness Coefficient [1]

Equipment Freshness Coefficient =

Net Value of Fixed Assets (Equipment) at the End of the Year (10,000 RMB) / Original Value of Fixed Assets (Equipment) at the End of the Year

 

The Role of the Equipment Freshness Coefficient [2]

1. The Rationale and Basis for Using the Equipment Freshness Coefficient to Evaluate Business Managers

 

The equipment freshness coefficient, as an indicator of equipment management in the machinery industry, was introduced in the "Requirements for the Level of Equipment Management in Machinery Industry Enterprises," formulated by the former Ministry of Machinery Industry in December 1982, which stipulated that the freshness coefficient of enterprise production equipment should be greater than 0.55. The "Regulations on Equipment Management and Maintenance in the Machinery Industry" clearly states that the factory director (manager) is responsible for the management of all production equipment in the factory and implements target management.  During their term of office, the total value of fixed assets and the freshness coefficient are included in the enterprise's economic contract responsibility system, and it is proposed to establish an audit system for equipment value. After the term of office expires, the total value of fixed assets and the freshness coefficient should have increased.

 

2. The Relationship Between the Equipment Freshness Coefficient and Other Relevant Business Indicators

 

Among the indicators used to evaluate business managers, the main indicator related to the equipment freshness coefficient is the return on capital, which is calculated as follows:

 

Return on Capital =

Realized Profit / (Average Occupancy Rate of Net Fixed Assets + Standard Working Capital) × 100%

 

In business objectives, in order to maintain and improve the equipment freshness coefficient, it is necessary to increase investment in fixed assets (equipment). This will increase the average occupancy of net fixed assets in the above formula, thus reducing the return on capital, and vice versa. If, in order to improve the return on capital, investment in fixed assets (equipment) is not increased, the equipment freshness coefficient will decrease. Therefore, the two indicators have a mutually restrictive effect. This encourages business managers to consider both aspects comprehensively and to fully utilize the investment efficiency of the equipment through comprehensive management. This ensures that while the average net value of fixed assets increases, profits also increase accordingly, leading to a simultaneous improvement in both the equipment newness coefficient and the return on capital.

 

During their term, business managers may purchase some new equipment, thus increasing the newness coefficient. However, neglecting equipment management and maintenance can lead to a "pushing the equipment to its limits" phenomenon, causing the technical condition of the equipment to deteriorate. This is still an undesirable practice. Therefore, the indicator of the pass rate of random inspections of well-maintained equipment should also be included in the business objectives. This differs from the equipment intact rate, which is the result of the company's own inspections. The calculation formula is:

 

Main production equipment intact rate =

Number of intact main production equipment / Number of main production equipment owned × 100%

 

The pass rate of random inspections of well-maintained equipment is the result of inspections conducted by the superior competent authority (i.e., the asset owner) on equipment that the company itself considers to be in good condition. Its calculation formula is:

 

Pass rate of random inspections of well-maintained equipment =

Number of well-maintained equipment passing random inspections / Number of well-maintained equipment inspected × 100%

 

Assessing the pass rate of random inspections of well-maintained equipment alongside the equipment newness coefficient encourages enterprises to focus on improving both the equipment newness coefficient and the technical condition of the equipment.

 

Ways to improve the equipment newness coefficient [2]

Taking a certain machinery factory as an example, let's illustrate the ways to improve the equipment newness coefficient. It is known that at the end of 1986, the original value of fixed assets was 27.2264 million yuan; the net value was 17.2264 million yuan. Among them, the original value of equipment was 13.718 million yuan, the net value was 8.657 million yuan, and the equipment newness coefficient was 0.63. The basic depreciation rate was 4.8%, and after deducting energy tax and pollution discharge fees of 2296, the actual available rate was 3.7%.

 

1. During the four-year term of the responsible manager, all depreciation funds extracted from fixed assets and equipment were used for the purchase of new equipment, and the amount extracted each year was used for equipment purchases in that year. If old equipment is not scrapped, and surplus and idle equipment is not actively dealt with and stored, then:

 

At the end of 1987, the original value of equipment = 1371.80 + 1371.80 × 3.7% = 1422.56 (ten thousand yuan)

 

Net value of equipment = 856.70 + 1371.80 × 3.7% - 137.80 × 4.8% = 850.61 (ten thousand yuan)

 

Newness coefficient = 850.61 ÷ 1422.56 = 0.6

 

At the end of 1988, the original value of equipment = 1422.56 + 1422.56 × 3.7% = 1475.19 (ten thousand yuan)

 

Net value of equipment = 850.61 + 1422.56 × 3.7% - 1422.56 × 4.8% = 843.96 (ten thousand yuan)

 

Newness coefficient = 843.96 ÷ 1475.19 = 0.57 (ten thousand yuan)

 

Using the same method, we can find:

 

The newness coefficient of equipment at the end of 1989 was 0.54;

 

The newness coefficient of equipment at the end of 1990 was 0.51.

 

 

Therefore, even if the responsible manager uses all the depreciation funds extracted from fixed assets and equipment for the purchase of new equipment, the equipment newness coefficient will still decrease by 0.03 each year for this factory manager.

 

2. During the four-year term, in order to maintain the freshness coefficient of the equipment, in addition to the depreciation funds for the fixed assets of the equipment, the remaining depreciation funds for fixed assets, or appropriations and loans from production development funds, technical measures, and technical transformation projects, were used for the purchase of new equipment (without considering the scrapping of old equipment and the disposal or mothballing of surplus and idle equipment). Let's assume that the equipment investment at the end of 1987 was X1 million yuan. Then:

 

Original value of equipment at the end of 1987 = 1371.80 + X1

 

Net value of equipment = 865.70 + X1 - 1371.80 × 4.8%

 

Freshness coefficient = (865.70 + X1 - 1371.80 × 4.8%) ÷ (1371.80 + X1) = 0.63

 

X1 = 177.97 (million yuan)

 

Using the same method, the equipment investment for 1988 can be calculated:

 

X1 = 201.05 (million yuan)

 

The equipment investment for 1989 should be:

 

X1 = 227.13 (million yuan)

 

The equipment investment for 1990 should be:

 

X1 = 256.59 (million yuan)

 

The total equipment investment over the four years is 862.74 million yuan.

 

From the above calculations, it can be seen that the person responsible for operations needs to invest 862.74 million yuan in equipment over the four-year term to maintain a constant equipment freshness coefficient.

 

From the analysis of the above two situations, it can be seen that to improve the freshness coefficient of the equipment, in addition to increasing equipment investment, the following two measures can be taken:

 

First, idle or underutilized equipment should be mothballed. If 30% of the equipment is mothballed annually during the term of the person in charge of operations, then:

 

At the end of 1987, the original value of the equipment = 1371.80 + 1371.80 × 3.7% × 70% = 1371.80 + 35.53 = 1407.33 (ten thousand yuan)

 

Net value of equipment = 865.70 + 35.53 - 1371.80 × 4.8% × 70% = 855.14 (ten thousand yuan);

 

Newness coefficient = 855.14 ÷ 1407.33 = 0.61;

 

Using the same method, we can find:

 

The newness coefficient of the equipment at the end of 1988 is 0.59;

 

The newness coefficient of the equipment at the end of 1989 is 0.57;

 

The newness coefficient of the equipment at the end of 1990 is 0.55.

 

Therefore, if 30% of the equipment is mothballed annually, the newness coefficient still decreases, but the rate of decrease is relatively small.

 

Secondly, actively handling and scrapping old equipment can not only maintain the newness coefficient of the equipment but also significantly improve it. Assuming that the total original value of the old equipment that has been fully depreciated within the four-year term is Y million yuan, then:

 

Net value of equipment = 865.70 - 0 = 865.70 (million yuan)

 

Original value of equipment = 1371.80 - Y

 

Newness coefficient = 865.70 ÷ (1371.80 - Y) = 0.70

 

Y = 135 (million yuan)

 

In summary, although improving the equipment newness coefficient is somewhat challenging, by comprehensively considering and effectively managing equipment procurement, the storage of idle equipment, and the disposal of old equipment, it is still possible to maintain and improve the equipment newness coefficient.