Return on Assets

Learning Outcomes

  • Calculate the rate of return on total assets

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]

Jonick Company
Comparative Income Statement
For the Years Ended December 31, 2019 and 2018
Description 2019
Subcategory, Other revenue and expenses
      Gain on sale of investments $137,000
      Interest expense (55,000)
Income before income tax $314,000
Income tax expense 66,000
Net income Single Line$248,000 Double Line
Jonick Company
Comparative Balance Sheet
December 31, 2019 and 2018
2019 2018
      Total current assets $911,000 $800,000
Subcategory, Long-term investments:
Investment in equity securities $1,946,000 $1,822,000
Subcategory, Property, plant and equipment:
      Total property, plant and equipment $1,093,000 $984,000
         Total assets Single Line$3,950,000Double Line Single Line$3,606,000Double Line

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.