Return on Assets Ratio and QuickBooks 2014 - dummies

Return on Assets Ratio and QuickBooks 2014

By Stephen L. Nelson

Track your return on assets ratio in QuickBooks. The return on assets shows the return that the firm delivers to stockholders and the interest that the firm pays to lenders as the percentage of the firm’s assets. Some businesses use return on assets to evaluate the business’s profitability. (Banks do this, for example.)

The actual formula is

(net income + interest)/total assets

In the case of the example business described in the following balance sheet and income statement, the net income equals $50,000. Interest expense equals $10,000. Total assets equal $320,000.

A Simple Balance Sheet
Cash $25,000
Inventory 25,000
Current assets $50,000
Fixed assets (net) 270,000
Total assets $320,000
Accounts payable $20,000
Loan payable 100,000
Owner’s equity
S. Nelson, capital 200,000
Total liabilities and owner’s equity $320,000
A Simple Income Statement
Sales revenue $150,000
Less: Cost of goods sold 30,000
Gross margin $120,000
Rent 5,000
Wages 50,000
Supplies 5,000
Total operating expenses 60,000
Operating income 60,000
Interest expense (10,000)
Net income $50,000

The formula to calculate this firm’s return on assets is

($50,000 + $10,000)/$320,000

This formula returns the value 0.188. This value indicates that the firm’s return (including both net income and interest) on its assets is roughly 19 percent.

No guideline exists for what a return on assets ratio should be. The main consideration is, predictably, that the return on assets must exceed the capital charges on the assets.

Capital charges aren’t complicated to understand. The bottom line is that a firm needs to deliver a return on its assets that exceeds the funding sources cost for those assets. In other words, if (on average) the creditor and shareholders providing money to a firm want something less than, for example, 19 percent, and the firm can earn 19 percent as its return on assets, that’s really good.

If, on the other hand, the return on assets percentage is 18.8 percent, but the funding sources for those assets cost 20 percent, well, that’s not so good. That firm is in trouble.

The term capital charge just equals the sum of the minimum profit that shareholders require to invest their money in a firm and the interest charges that lenders require for the money that they’ve loaned to the firm.