Definition: Return on assets, often called return on total assets, is a financial ratio that measures how efficiently and profitably a company can manage their income producing assets.
What Does Return on Assets Mean?
The return on assets formula is calculated by dividing net income by the average total assets during the period. This shows the income that each dollar invested in assets produces during the period. Managers can use this information to see what assets are producing the most return and steer the focus of the company to those types of operations.
Take Corning Machinery, Inc. for example. Corning is a manufacturing plant the produces tool and dye parts for other machining operations. Its management is looking to expand operations but doesn’t know what CNC machines will be better in the long run. The managerial accountants decided to do a return on asset test to analyze their current machines.
The first set of machines cost $100,000 and were able to produce $200,000 of net income. This means the first machines have a return on asset ratio of two. In other words, the return on every dollar spent on these machines brings in $2 of income.
The second set of machines cost much more. They cost $800,000 and were able to bring in $1,500,000 of net income. The return on assets ratio for this set of machines is 1.88. This means that every dollar invested in the second set of machines only brings in $1.88 of income.
Although the second set of machines actually brings in more sales dollars, it actually performs less efficiently and profitably than the first set. When the management decides to expand the factory operations, they should purchase machines similar to the first set since the return is much higher than the second set.