Return on assets measures how effectively a company uses its assets to generate income. It is roughly equivalent to an investor’s overall portfolio rate of return.

To calculate return on assets, add interest expense back to net income, and divide by average total assets.

[latex]\dfrac{\text{interest expense} + \text{net income}}{\text{average total assets}}[/latex]

In our hypothetical example, net income is $248,000. Interest expense relates to financed assets, and it is added back to net income since how the assets are paid for should be irrelevant. This also makes the calculation more comparable between companies that use debt financing and companies that use equity financing.

Adding back $55,000 in interest expense gives us $303,000 in investment income, divided by $3,778,000—the average of beginning and ending total assets [latex]=\dfrac{\left(3,950,000+3,606,000\right)}{2}[/latex]—equals a rate of return on assets of .08020116 or roughly 8%. The higher the rate of return, the better, and this will vary from industry to industry and also according to current economic conditions. For instance, if the Federal Reserve is using monetary policy to depress overall interest rates, 8% might be a good rate of return. If however, the stock market is returning 10% or better, an 8% rate of return might not be appealing to an investor.

However, as with any high-level metric, this ratio has to be considered both in a larger context (e.g. over a long period of time) and as part of a larger analysis (e.g. other metrics, such as earnings per share or dividend payout may still make this an appealing investment.)

Now that you have learned about the rate of return on total assets, let’s practice your understanding.