Definition: Segment return on assets is a financial ratio that shows the profitability of a business segment by comparing operating income to average assets. In other words, it’s a ratio that shows how efficiently one part of a business can use its assets to generate operating income.
What Does Segment Return on Assets Mean?
This type of financial analysis is extremely important for a company that is looking to either expand operations or downsize capacity. Think about it this way. Not every part of the business will always produce profits. Some will break even and some will generate losses. Management has to take a deeper look at each segment before deciding to expand or cut it.
This ratio shows management which sectors of the company are using their assets the most effectively. This means management will be able to see what parts of the company deserve higher investments in assets.
The segment return on assets ratio equation is calculated by dividing the segment operating income by the segment average assets.
Take Harley Davidson for example. It has many different divisions and departments, but we will look at the motorcycle manufacturing division and the financing division in particular. The manufacturing segment obviously requires more capital and assets in order to run. Each factory and plant is a huge investment for the company.
The financial services sector, on the other hand, often requires little capital outlay and asset investment, but also only makes a small percentage of what the manufacturing side of the business makes.
This is where GM ran into problems. Before the bail out in the early 2000s, GM was actually making more money from financing its vehicle sales to customers instead of actually manufacturing them. This was a bad sign for the manufacturing segments and needed a drastic corporate overhaul in order to fix.