Return on assets is a key metric in financial statement analysis that shows how effectively a company uses its total assets to generate profit. It is used to assess the company’s overall earning capacity relative to the resources tied up in its assets.
Formula for return on assets
Return on assets is typically calculated as:
Return on assets = (Operating profit / Average assets) × 100
- Operating profit (also called EBIT) is the company’s profit before interest and tax.
- Average assets is calculated as the sum of the company’s assets at the start and end of the period divided by two.
Why is return on assets important?
This key ratio shows how well the company creates value with the resources it has available. A high return on assets indicates that the company uses its assets efficiently, while a low return on assets may be a sign of inefficiency or earnings that are too low relative to the asset base.
Practical use
Return on assets is often used by:
- Investors, who want to compare companies across industries.
- Creditors and banks, who want to assess whether the company has a healthy earning capacity.
- Management, who can track progress over time and assess whether resources are being used optimally.
Links to other KPIs
Return on assets is closely linked to other key ratios, such as:
- profit margin, which shows what proportion of revenue becomes profit.
- Asset turnover, which shows how many times assets “turn over” through the year’s sales.
Together, these figures can provide a more nuanced view of the company’s efficiency and profitability.
Example
A company has operating profit (primary operations) of DKK 5m and average assets of DKK 50m.
Calculation: (5,000,000 / 50,000,000) × 100 = 10%
The return on assets is therefore 10%, which means the company has earned DKK 0.10 for every DKK 1 invested in assets.