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What is a Return On Assets?
What’s important to know about it?
In this article, I will break down the meaning of Return On Assets so you know all there is to know about it!
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Let me explain to you what Return On Asset is and why it’s important!
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What Is Return On Assets
Return on asset is a profitability ratio allowing you to measure how profitable a company is in relation to the assets it owns.
In other words, return on assets tells you how well a company is using its assets to generate profits.
To determine the return on assets, you’ll need to identify a company’s net income and the average value of its assets during the period you are evaluating.
For example, if a company had generated a net income of $1,000,000 and had an average asset value of $10,000,000, the company’s return on assets is 10%.
The return on asset financial ratio is typically used along with other profitability ratios allowing company management, investors, and analysts to evaluate the overall profitability of a company.
What’s interesting with the return on asset is that since you’re taking the company’s net income, you are factoring in the company’s debt obligations in the ratio.
Keep reading as I will further break down the return on assets and go over an example with you.
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Why Is Return On Assets Important
Return on asset is a financial ratio allowing you to measure how efficiently a company is using its assets to generate revenues.
There are different types of financial ratios that you can use to evaluate profitability such as comparing a company’s revenues to its net profits.
However, understanding how well a company is utilizing its assets to generate profits is also an important financial measure.
The return on assets tells you in a quick and simple way how well is the company investing its resources into productive assets.
When a company measures its return on assets over time and compares it to its competitors or other companies in the same industry, it could assess how well it is utilizing its invested capital to generate profits.
If a company is not using its assets productively, company management should identify the areas that need improvement and implement changes.
Alternatively, if the company is generating a good return on asset, it knows that it should remain consistent.
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How To Calculate Return On Assets
Here is the return on asset formula that you need to calculate your return on asset:
Return On Asset = Net Income / Total Assets
As you can see, the formula is quite simple.
All you need is to take the company’s net income from its income statement and total average assets from its balance sheet.
For example, a company that generates $25,000 of net income using total assets of $100,000 will have a return on asset of 25%.
Keep in mind that you should not look at the return on asset alone and in a vacuum.
It’s important to look at return on asset along with other profitability ratios so you can get a better idea of the company’s performance.
The return on asset figures can also vary greatly from one industry to another so it’s important to compare companies in the same industry.
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When To Use Return On Assets
There are many reasons why companies calculate their return on asset.
Here are the main reasons why and when you will want to calculate return on asset.
You should calculate return on asset if you’re looking to determine the profitability and efficiency of a company.
Return on asset measures how much money you are earning on every dollar of asset you own.
The higher your return on asset, the more your assets are generating profits.
You should use return on asset to measure the performance of one company compared to another.
Since the return on asset is a simple and easy figure to calculate, you can quickly compare companies in within the same industry.
This way, you can assess how well a company is doing compared to its peers.
You can also assess how intensively a company is relying on its assets to generate a return.
Typically, companies that are asset-investive will have a lower return on asset than companies that are less asset-intensive.
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Return On Asset Example
Let’s look at an example of return on asset to better understand the concept.
Let’s take an asset-intensive company that is looking to measure its return on assets.
The company uses a lot of machines and equipment to produce its goods.
It had a total of $10,000,000 in assets in a given period.
If the company generates $10,500,000 in net income, it means that its return on asset is 5%.
Typically, companies that have a lot of assets will have a lower return on asset.
Let’s take a company that does not have a lot of assets to generate revenues such as a technology company.
The company has a total of $10,000,000 in assets and generates a net income of $15,000,000.
It has a return on assets of 50%.
It’s typical to see asset-light companies have a higher return on assets.
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Return On Asset FAQ
What is a good return on asset?
Just like many other financial ratios, a good return on assets will depend on the nature of your business and other factors.
Companies that invest in a lot of assets to generate revenues will have a lower return on assets than companies that are asset-light.
Typically, asset-heavy companies should aim for a return on assets of 5% or more whereas asset-light companies should aim for 20% or more.
It’s important that you compare the return on assets to similar companies in the same industry to get a sense of your benchmark.
What’s the difference between return on asset and return on equity?
Both returns on asset and return on equity are profitability ratios allowing you to calculate the company’s profitability.
The return on asset measures how well a company is using its assets to generate returns whereas the return on equity assesses how well it is using its equity to generate a return.
The main difference between the return on asset and return on equity is that return on asset considers a company’s debt level or leverage whereas the return on equity does not.
Return on asset uses net income which includes the impact of debt on the company’s revenues.
When you’re looking at a company’s equity, you are essentially deducting any liabilities thereby utilizing the company’s net assets.
How to analyze return on assets?
There are two primary ways you can analyze a company’s return on assets: over time and in relation to other companies in the same industry.
The first way is to assess the evolution of a company’s return on assets over time.
If the ratio is improving with time, the company is becoming more efficient in using its assets (and vice versa).
Also, doing competitive analysis by comparing the company’s return on assets to companies in the same industry will tell you where the company is situated compared to the industry.
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So there you have it folks!
What does return on asset mean?
In a nutshell, return on asset is a financial measure allowing you to see how well a company is using its assets to generate profits.
The return on assets measures the ratio between the company’s net income in relation to the capital it has invested in its assets.
The higher the return on assets, the more the company is generate profits from its assets.
Companies should regularly assess their profitability ratios to see where they can improve so they can ultimately become more efficient.
Now that you know what return on asset is and how it works, good luck with your research!
I hope you enjoyed this article on Return On Asset! Be sure to check out more articles on my blog. Enjoy!
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