Return on assets: formula, examples & interpretation

Return on assets is an important business ratio. It reflects how efficiently a company has managed all its capital over a certain period of time. What the return on assets is, what it means and how it is calculated, you will learn in this article. Easy-to-understand examples help you to understand how the return on total capital of a company can be determined.

What is the return on assets?

The return on assets is also known as return on assets or return on total assets. This important key figure indicates how the interest rates behave in relation to the total capital employed by a company.

To calculate the return on assets, both the company's own capital employed and the borrowed capital, for example in the form of loans, are taken into account. From this value you can see what return the company has actually generated. The return on assets thus expresses relative profits of the company.

To understand what return on assets is all about, you first need to know the different forms of return on investment. In addition to return on assets, return on equity is also an important metric. Return on equity is only one part of return on assets. In addition to the money used from its own reserves, there is also the capital that a company has received from third parties. This can be the case, for example, through loans taken out.

The question answered by the return on assets is: what did the debt and equity of a company together generate? Everything on the liability side is important for this purpose.

What is the importance of the return on assets?

How profitable a company uses its own capital, indicates the return on equity. However, this is only meaningful to a limited extent, as companies also use debt capital. For this, the return on assets is an important key figure. This value has a higher significance than the pure return on equity, because it can not be glossed by accounting tricks.

Return on assets indicates how efficiently a company used all of its capital – regardless of the source of that money. This controlling ratio is therefore important for successful business management. It indicates how efficient a company is.

A higher return on assets means that the company is more profitable in terms of the capital employed, or has managed the money available to it more efficiently. What value is desirable depends heavily on the individual goals of the company, but also on the industry. For some companies, values between 7 and 10 percent are sufficient. Companies that want to grow more strongly and take on more risks sometimes set themselves a target of up to 25 percent return on assets.

The ratio helps to determine whether the use of borrowed capital for future investments is worthwhile or not. It is not only the return on assets that is important, but also the interest rate on the borrowed capital used. This is typically between 10 and 15 percent. If the interest rate for borrowed capital is lower than the return on total capital, it makes sense for a company to use borrowed capital.

Return on assets: important key figure for investors

Return on assets is not only important for managing the company. It also has great significance for investors who are considering whether or not to invest in a particular company. This value can be used to gauge how promising it is to be an investor in the company in question. The potential of an enterprise is also evident from it. Whether it is solidly positioned or not can be seen in its return on assets.

A company with a high return on assets is attractive for investors. Scores above 15 percent are considered very good. Values of at least 10 percent are desirable. However, this value depends on the industry in question. In the retail sector, for example, the value should be higher than in the industrial sector, where even values below 10 percent can be enough.

However, when it comes to the question of whether an investment is worthwhile or not, it is not only the last accounting period that is important. A more reliable picture is obtained by looking at the return on assets over a longer period of time. Here's how to track the company's performance.

Is the value always comparable?

Within an industry, a value can usually be compared well with values of other companies. This applies across industries to a limited extent. However, it is important to keep in mind that differences may also arise due to the different forms of balancing. Different types of accounting, such as IFRS or HGB, can lead to different results. Other factors, such as the particular approach to depreciation, can also affect the return on assets.

The field of activity of a company also has an influence on profit and thus also on the return on assets. Investments are not always capitalized in the balance sheet. It can also be expensed, as may be the case for companies engaged in research or software development. This results in lower profits and a lower return on assets.

How is the return on assets calculated?

To determine the profit of a company, the interest must be deducted from the turnover. However, to calculate the return on assets, the interest must be added back to the revenue to get a meaningful overall picture. While the interest on borrowed capital goes to the lender, the net profit remains in the company.

To calculate the return on assets, you add the profit (as net income) with the interest on debt in euros. The interest on borrowed capital is calculated by multiplying the debit interest and the borrowed capital used. The profit for a year and the cost of using the borrowed capital in the form of the interest on borrowed capital together give the so-called period profit of a company.

Now divide the sum of net income and interest on borrowed capital by the sum of equity capital and borrowed capital. Together, they make up the total capital of a company. Multiply this value by 100 to get a percentage value.

The formula for calculating return on assets is:

Example 1 of the calculation of return on assets

The company Mummelmann produces pet food and made a profit of 15 million euros in 2017. For the borrowed capital used during this period interest was incurred in the amount of 1 million euros. The total capital deployed by the company Mummelmann amounted to 300 million euros.

So now we add up 15 million euros (profit) with 1 million euros (interest on debt). The company's profit for the period, which now appears to be 16 million euros, is divided by the total capital in the next step. Thus, we divide 16 / 300 (million euros). The result is 0.533. To arrive at a percentage value, multiply this result by 100. So, Mummelmann's return on total capital in 2017 was 5.33 percent.

Example 2 to calculate the return on assets

The startup FastCharge manufactures charging stations for electronically powered vehicles. It is important for potential investors to know how the company's return on assets is doing. FastCharge's profit in 2016 was 50.000 euros. The startup has used borrowed capital with an interest rate of 15.000 euros lay. Equity and debt together amounted to 400.000 euros.

In order to calculate the return on total capital, the period profit of FastCharge is important. It was 50 in 2016.000 euros plus 15.000 euros, i.e. a total of 65.000 euros. Next, we divide this value by the total capital. This amounted to 400.000 Euro. 65.000 euros divided by 400.000 euros results in 0.1625. To obtain a value in percent, we multiply the result by 100. Now we know that FastCharge's return on assets was 16.25 percent. The startup's total capital could thus earn interest at 16.25 percent.