Return on Assets

Examples of Return on Assets in the following topics:

• Return on Assets

  • The Return on Total Assets ratio measures how effectively a company uses its assets to generate its net income.
  • The Return on Total Assets ratio is similar to the Asset Turnover Ratio in that both measure how effective a business's assets are in generating returns for the business.
  • But while the asset turnover ratio is focused on the business's sales, return on assets is focused on net income.
  • $Return\quad on\quad Total\quad Fixed\quad Assets\quad =\quad \frac { Net\quad Income }{ Average\quad of\quad Fixed\quad Assets }$
  • However, merely determining a business's return on asset ratio is insufficient to get a good understanding on how a business is doing.

• Relationships between ROA, ROE, and Growth

  • Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
  • Return on assets is equal to net income divided by total assets.
  • In other words, return on assets makes up two-thirds of the DuPont equation measuring return on equity.
  • Return on assets is equal to net income divided by total assets.
  • Discuss the different uses of the Return on Assets and Return on Assets ratios

• Return on Total Assets

  • The return on assets ratio (ROA) measures how effectively assets are being used for generating profit.
  • The return on assets ratio (ROA) is found by dividing net income by total assets.
  • It is also a measure of how much the company relies on assets to generate profit.
  • Second, the total assets are based on the carrying value of the assets, not the market value.
  • The return on assets ratio is net income divided by total assets.

• Return on Investment

  • Return on investment (ROI) is one way of considering profits in relation to capital invested.
  • Return on investment (ROI) is one way of considering profits in relation to capital invested.
  • Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined .
  • The purpose of the "return on investment" metric is to measure per-period rates of return on dollars invested in an economic entity.
  • Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined.

• The Value of Diversification

  • The compensation adjustment for holding an asset of a given risk profile can be further enhanced through asset diversification.
  • The risks that are inherent to a specific investment can be compensated for by a market-assessed risk premium, whereby market participants adjust the price of an asset, impacting its overall return, based on the risk characteristics of the asset.
  • By holding varying investments, even if they are within the same company or sector, an investor still has the benefit of reducing risk inherent from the default of one asset.
  • In some cases where the return on investment needs to be met, managers may advocate for the use of hedging instruments to transfer risk of return objectives being met to another party in lieu of a consistent return.
  • The party on the opposite side of the hedge absorbs both the upside and downside return potential of the asset, along with the fee for taking on the risk of uncertainty, and pays the first party a constant return as part of the agreement.

• The SML Approach

  • Expected return = 5% + 1.9*(12% - 5%) Expected return = 18.3% We expect the asset to return 18.3% and be plotted on the SML.
  • However, the current real rate of return for the asset is 19%.
  • Individual assets that are correctly priced are plotted on the SML.
  • In the ideal world of CAPM, all assets are correctly priced and thus lie on the SML.
  • Conversely, an asset priced below the SML is overvalued, since for a given amount of risk, it yields a lower return.

• Reporting

  • A realized return is the difference between the sale price of the asset and the purchase price.
  • The difference between realized and unrealized returns is that realized returns result from the actual sale of the asset, while unrealized returns occur when the asset is not sold and result from a change in the market price.
  • These returns appear separately on the firm's financial statements, and have different tax implications as well.
  • While realized returns are reported on the income statement (and affect the cash flow statement) and unrealized returns are reported on the balance sheet, only realized returns have tax implications.
  • The IRS taxes only realized returns, though financial reports must also include unrealized returns on the balance sheet.

• The Relationship Between Risk and Return and the Security Market Line

  • Non-diversifiable risk is noted by the variable beta (β), where beta is greater than one if the asset's price sensitivity is greater than the market; equal to one when the asset's sensitivity is equal to the market; and less than one if the asset exhibits less pricing volatility than the market.
  • The expected return of an asset is equal to the risk free rate plus the excess return of the market above the risk-free rate, adjusted for the asset's overall sensitivity to market fluctuations or its beta.
  • Mathematically, the capital asset pricing model can be written as: E(Ri) = Rf + β(E(Rm) - Rf), where R is the return, E(R) is the expected return, i denotes any asset, f is the risk-free asset, and m is the market.
  • The relationship between β and required return is plotted on the SML, which shows expected return as a function of β.
  • The security market line depicts the the return on a security relative to its own risk.

• Expected Risk and Risk Premium

  • The notion of risk implies that a choice having an influence on the outcome exists.
  • This type of risk is uncorrelated with broad market returns, and with proper grouping of assets can be reduced or even eliminated.
  • The term risk premium refers to the amount by which an asset's expected rate of return exceeds the risk free rate.
  • The difference between the return of an asset in question and that of a risk-free asset -- for instance, a US Treasury bill -- can be interpreted as a measure of the excess return required by an investor on the risky asset.
  • Beta is a measure that relates the rate of return of an asset, ra, with the rate of return of a benchmark, rb.

• Components of the Balance Sheet

  • The balance sheet relationship is expressed as; Assets = Liabilities + Equity.
  • The balance sheet contains statements of assets, liabilities, and shareholders' equity.
  • A business incurs many of its liabilities by purchasing items on credit to fund the business operations.
  • A company's equity represents retained earnings and funds contributed by its owners or shareholders (capital), who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.
  • Generally, sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables, and fixed assets (plant, property, and equipment).