How to evaluate how correctly and effectively a company uses its capabilities? How can you even value a company in order to sell it or attract investors? For a competent analysis, relative and absolute indicators are used, which allow one to draw conclusions not only about the monetary value, but also about the prospects for purchasing/investing in the project. One of these indicators is return on assets, the calculation formula for which will be given below. In our article you will learn about what this term means, when it is used and what it shows.
Introduction
For a competent assessment economic activity it is necessary to combine relative and absolute indicators. The first talk about how profitable and liquid the company is, whether it has prospects and chances to remain on the market during crises. It is by relative indicators that two companies operating in the same fields are compared.
Return on assets shows the efficiency of your property
Absolute indicators are numerical/monetary values. This includes profit, revenue, product sales volumes and other values. A correct assessment of an enterprise is possible only by comparing two indicators.
What is RA
The term “return on assets” sounds like English as return on assets and has the abbreviation ROA. Knowing it, you can understand how efficiently the company uses its existing assets. This is a very important indicator that allows you to conduct a global analysis of your company’s economic activities. That is, to put it simply, return on assets is the efficiency of your property.
On at the moment Three types of ROA are used:
- Classic return on assets (ROA).
- Profitability of existing current assets.
- Profitability of existing non-current assets.
Let's look at these concepts. Current assets describe the company's existing assets, which are indicated in the balance sheet (section number 1), as well as in lines 1210, 1230 and 1250. This property must be used for production cycle or one calendar year. These assets influence the cost of a company's final service or manufactured product. This usually includes:
- Existing accounts receivable.
- Value added tax.
- Working capital “frozen” in warehouses and production.
- Currency and other equivalents.
- Various short-term loans.
The higher the return on assets, the more profit the company makes
Experts divide OO into three types:
- Cash (loans, short-term investments, VAT, etc.).
- Material: raw materials, workpieces, supplies.
- Intangible: receivables and equivalents.
Second, no less important concept, these are non-current assets of the enterprise. This term includes all property that is used more than a year and is displayed in 1150 and 1170 lines. These assets do not lose their properties over a long period of time (but are subject to depreciation), therefore they add only a small part to the cost of the final service or product. This term includes:
- key property of the company (office and industrial buildings, transport, equipment, machines);
- classic intangible assets (reputation, brand, licenses, existing patents, etc.);
- existing long-term loans and liabilities.
Read also: What is fixed capital
These assets are also divided into three types, like current ones.
How to calculate
In order to find out the return on assets ratio, you can use the formula (PR/ASR)*100%. The formula may also look like this: (PE/Asp)*100%. By taking profit data and calculating the corresponding values, you will find out how much money each ruble invested in the company’s property brings in and whether the assets can generate profit at all.
A high return on assets ratio is usually observed in trading and innovative enterprises
To find how much profit your assets are generating, you can use the TR-TC formula. Here TR stands for cost revenue and TC stands for cost of the product/service. To find TR, use the formula P*Q, where Q is sales volume and P is the cost of one product.
To find the cost, you need to find data on all the costs of the enterprise for a production cycle or a certain time and add them up. Costs include rent, utilities, salary for workers and management, depreciation, logistics, security, etc. Knowing the cost, you can calculate the net profit: TR-TC-PrR+PrD-N. Here N stands for taxes, PrR stands for other expenses, PrD stands for other income. PrD and PrR are terms that denote income and expenses that are not directly related to the company’s activities.
We count according to the balance
There is a special formula for return on assets on the balance sheet - it is usually used if the data is completely open . The balance sheet indicates the number and value of assets at the beginning and end of the year. You can find out profitability quite simply - calculate the arithmetic average for each section of the balance sheet from lines 190 and 290. This way you will find out the cost of non-current and current assets. IN small companies the calculation is done on lines 1150 and 1170, as a result you will find out the average annual cost of VnA.
Then we use the formula ObAsp = ObAnp + ObAkp. Here everything is the same as in the previous formula, and ObA denotes the value of current assets. Now we add the two resulting numbers and get the average annual value of the company’s property. This is done using the formula Asp = ObAsp + InnAsr.
Return on assets is a relative indicator that can be used to compare businesses
Based on this, we can conclude: return on assets shows the return on your company’s assets. The higher this ratio, the higher the profit and the lower the costs. That is why you need to strive to make your property more profitable, and not a hanging dead weight and devouring your existing reserves.
Net assets are the real value of the company's property assets, which must be calculated annually. The size of net assets is the difference between the value of property on the balance sheet and debt obligations.
Return on net assets reflects how effectively the company's capital structure is managed, as well as the company's ability to efficiently manage its own and borrowed funds.
If the profitability indicator NA has negative value , which means that the amount of debt obligations is greater than the value of the company’s property assets.
If, at the end of the year, the size of the private equity is less than the size of the capital, the company will need to reduce the size authorized capital up to the amount of net assets. If, as a result of the reduction, the size of the charter capital is less than the legally established size, the company will be forced to announce its liquidation.
Return on assets based on net profit - formula
The formula for calculating the return on assets based on net profit will be as follows:
Kra = size of net profit / size of net assets.
Return on net assets - balance sheet formula
Kra = s. 2300 second form / (since 1600 ng first form + since 1600 kg first form) / 2, where:
- P. 2300 – line reporting losses and profits (second form);
- S. 1600 – book line. balance (first form).
If you need to estimate the profitability of sales by profit, read on our website.
Return on net assets ratio
The growth of this coefficient can be caused by:
- An increase in the company's net profit;
- Increasing the size of the asset turnover ratio;
- An increase in prices for services provided or goods sold;
- Reducing the costs of manufacturing products or providing services.
A decrease in the indicator may be caused by:
- A decrease in the company's net profit;
- A decrease in the value of the asset turnover ratio;
- An increase in the price of fixed assets, as well as current and non-current assets.
Standard value of the indicator
The return on net assets indicator is the most important indicator for investors, since it reflects the amount of profit attributable to the amount of equity capital. It can be expressed either in cost or percentage terms.
The standard value for the indicator is more than 0. If the value is less than 0, this is a serious reason for the company to think about the effectiveness of its activities. This is due to the fact that the company operates at a loss.
Directions for using the coefficient
The return on assets ratio is used financially. analysts to diagnose the company's performance.
This indicator reflects the financial return on the use of the company's assets. The purpose of its use is to increase its value (taking into account the level of liquidity of the company), that is, using it, the analyst can quickly analyze the composition and structure of the company’s assets, as well as assess their contribution to the formation of total income. If any asset does not bring profit, the best solution would be to abandon it.
Simply put, return on assets is an excellent indicator of a company's overall profitability and performance.
Profitability indicators characterize the financial results and efficiency of the enterprise. They measure the profitability of an enterprise from various positions and are grouped in accordance with the interests of participants in the economic process and market exchange.
Profitability indicators are important characteristics of the factor environment for generating enterprise profits. Therefore, they are mandatory when conducting a comparative analysis and assessing the financial condition of an enterprise. When analyzing production, profitability indicators are used as a tool for investment policy and pricing.
To determine the efficiency of an enterprise, three profitability indicators will be considered: return on sales, return on assets and return on equity.
Return on sales ratio(ROS). This indicator reflects the efficiency of the enterprise and shows the share (as a percentage) of net profit in the total revenue of the enterprise. In Western sources, the return on sales ratio is called ROS ( return on sales).
It is advisable to begin studying any coefficient with its economic meaning. Return on sales reflects the business activity of an enterprise and determines how efficiently the enterprise operates. The coefficient shows how much cash from the products sold is the profit of the enterprise. What is important is not how many products the company sold, but how much net profit it earned from these sales.
The return on sales ratio describes the efficiency of sales of the company's main products, and also allows you to determine the share of cost in sales.
The formula for return on sales according to the Russian accounting system is as follows:
Coef. return on sales = Net profit / Revenue * 100%, % (1)
It should be clarified that when calculating the ratio, instead of net profit in the numerator, the following can be used: gross profit, earnings before taxes and interest (EBIT), earnings before taxes (EBI). Accordingly, the following coefficients will appear:
Coef. rent sales by val. profit = Val. profit / Revenue * 100%, % (2) Coefficient. operating profitability = EBIT / Revenue * 100%, % (3) Coefficient. rent sales by profit before taxes = EBI / Revenue * 100%, % (4)
To calculate all the above profitability indicators, the data contained in the 2nd form of financial statements - “Report on financial results” is sufficient.
In foreign sources, the return on sales ratio is calculated using the following formula:
ROS = EBIT / Revenue * 100%, % (5)
The standard value for this ROS coefficient is > 0. If the return on sales is less than zero, then you should seriously think about the efficiency of enterprise management.
– mining – 26% – agriculture – 11% – construction – 7% – wholesale and retail – 8%
Return on assets (ROA) ratio. It shows how much cash is available per unit of assets available to the enterprise. Allows you to evaluate the quality of work of its financial managers.
This ratio shows the financial return from the use of the company's assets. The purpose of its use is to increase its value (taking into account the liquidity of the enterprise), that is, with its help, a financial analyst can quickly analyze the composition of the enterprise’s assets and evaluate their contribution to the generation of total income. If any asset does not contribute to the income of the enterprise, then it is advisable to abandon it (sell it, remove it from the balance sheet). In other words, return on assets is an excellent indicator of the overall profitability and efficiency of an enterprise.
Return on assets is calculated using the following formula:
Return on assets ratio = Net profit / Assets * 100%, % (6)
The result of the calculation is the amount of net profit from each ruble invested in the organization’s assets. The indicator can also be interpreted as “how many kopecks each ruble invested in the organization’s assets brings in.”
The organization's net profit is taken according to the "Income Statement", assets - according to the Balance Sheet.
In Western literature, the formula for calculating return on assets (ROA, Return of assets) is as follows:
ROA = NI / TA *100%, % (7)
where: NI – Net Income (net profit) TA – Total Assets (total assets)
An alternative way to calculate the indicator is as follows:
ROA = EBI / TA *100%, % (8)
where: EBI is the net profit received by shareholders.
The standard for the return on assets ratio, as for all profitability ratios, is ROA > 0. If the value is less than zero, this is a reason to seriously think about the efficiency of the enterprise. This will be caused by the fact that the enterprise operates at a loss.
Coefficientprofitabilityequity(return on equity, ROE). This is a measure of net profit compared to the organization's equity capital. This is the most important financial indicator of return for any investor or business owner, showing how effectively the capital invested in the business was used. Unlike the similar indicator “return on assets,” this indicator characterizes the efficiency of using not all of the capital (or assets) of the organization, but only that part of it that belongs to the owners of the enterprise.
Return on equity is calculated by dividing net profit (usually for the year) by equity organizations:
Rent. own cap. = Net profit / Equity * 100%, % (9)
A more accurate calculation involves using the arithmetic average of equity for the period for which net profit is taken (usually for the year) - equity at the end of the period is added to equity at the beginning of the period and divided by 2.
The organization's net profit is taken according to the "Income Statement" data, equity capital - according to the liabilities of the Balance Sheet.
A special approach to calculating return on equity is to use the Dupont formula. The Dupont formula breaks the indicator into three components, or factors, that allow a deeper understanding of the result obtained:
Return on Equity (Dupont Formula) = (Net Income / Revenue) * (Revenue / Assets) * (Assets / Equity) = Net Income Return * Asset Turnover * Financial Leverage (10)
According to average statistical data, return on equity is approximately 10-12% (in the USA and UK). For inflationary economies, such as the Russian one, the figure should be higher. The main comparative criterion when analyzing return on equity is the percentage of alternative return that the owner could receive by investing his money in another business. For example, if a bank deposit can bring 10% per annum, but a business brings only 5%, then the question may arise about the advisability of further running such a business.
The higher the return on equity, the better. However, as can be seen from the Dupont formula, a high value of the indicator can result from too high financial leverage, i.e. a large share of borrowed capital and a small share of equity capital, which negatively affects the financial stability of the organization. This reflects the main law of business - more profit, more risk.
Calculating return on equity makes sense only if the organization has equity capital (i.e., positive net assets). Otherwise, the calculation gives a negative value that is of little use for analysis.
Performance indicators can be divided into direct and inverse. Direct efficiency indicators are return coefficients, which show what standard unit of result is obtained from a standard unit of costs for its production. Inverse efficiency indicators are capacity coefficients, which illustrate how many conventional units of input are needed to obtain a conventional unit of result.
One of the main indicators of the efficiency of an enterprise's economic activities is profitability. Profitability indicators are less susceptible to the influence of inflation and are expressed by different ratios of profit and costs. Profitability indicators are mainly measured in the form of ratios.
Profitability
Profitability can be defined as an indicator of economic efficiency, reflecting the degree of efficiency in the use of material, monetary, production, labor and other resources.
Profitability indicators are divided into different groups and are calculated as the ratio of the selected meters.
The main types of profitability are the following indicators:
- Return on assets.
- Profitability of main production assets.
- Sales profitability.
Return on assets
Return on assets is a financial ratio showing the profitability and efficiency of an enterprise. Return on assets shows how much profit an organization receives from each ruble spent. Return on assets is calculated as the quotient of net profit divided by average assets, multiplied by 100%.
Return on assets = (Net profit / Average annual assets) x 100%
The values for calculating return on assets can be taken from the financial statements. Net profit is indicated in Form No. 2 “Profit and Loss Statement” (new name “Income Statement”), and the average value of assets can be obtained from Form No. 1 “ Balance Sheet" For accurate calculations, the arithmetic average of assets is calculated as the sum of assets at the beginning of the year and the end of the year, divided by two.
Using the return on assets indicator, you can identify what the discrepancies between the projected level of profitability and real indicator, and also understand what factors influenced the deviations.
Return on assets can be used to compare the performance of companies in the same industry.
For example, the value of the enterprise’s assets in 2011 amounted to 2,698,000 rubles, in 2012 – 3,986,000 rubles. Net profit for 2012 is 1,983,000 rubles.
The average annual value of assets is equal to 3,342,000 rubles (arithmetic average between the indicators of the value of assets for 2011 and 2012)
Return on assets in 2012 was 49.7%.
Analyzing the obtained indicator, we can conclude that for each ruble spent the organization received a profit of 49.7%. Thus, the profitability of the enterprise is 49.7%.
Profitability of fixed production assets
Profitability of fixed production assets or profitability of fixed assets is the quotient of net profit divided by the cost of fixed assets, multiplied by 100%.
Profitability of OPF = (Net profit / Average annual cost of fixed assets) x 100%
The indicator shows the real profitability from the use of fixed assets in the production process. Indicators for calculating the profitability of fixed production assets are taken from financial statements. Net profit is indicated in Form No. 2 “Profit and Loss Statement” (new name “Statement of Financial Results”), and the average value of fixed assets can be obtained from Form No. 1 “Balance Sheet”.
For example, the value of the enterprise's fixed production assets in 2011 amounted to 1,056,000 rubles, in 2012 – 1,632,000 rubles. Net profit for 2012 is 1,983,000 rubles.
The average annual cost of fixed assets is 1,344,000 rubles (arithmetic average of the cost of fixed assets for 2011 and 2012)
The profitability of fixed production assets is 147.5%.
Thus, the real return on the use of fixed assets in 2012 was 147.5%.
Return on sales
Return on sales shows what portion of an organization's revenue is profit. In other words, return on sales is a coefficient that illustrates what share of profit is contained in each ruble earned. Return on sales is calculated for a given period of time and expressed as a percentage. With the help of sales profitability, an enterprise can optimize costs associated with commercial activities.
Return on sales = (Profit / Revenue) x 100%
Return on sales values are specific to each organization, which can be explained by differences in the competitive strategies of companies and their product range.
Can be used to calculate return on sales various types profit, which causes the existence of different variations of this coefficient. The most commonly used are return on sales calculated based on gross profit, operating return on sales, and return on sales calculated based on net profit.
Return on sales by gross profit = (Gross profit / Revenue) x 100%
Return on sales based on gross profit is calculated as the quotient obtained by dividing gross profit by revenue multiplied by 100%.
Gross profit is determined by subtracting cost of sales from revenue. These indicators are contained in Form No. 2 “Profit and Loss Statement” (new name “Statement of Financial Results”).
For example, the gross profit of the enterprise in 2012 was 2,112,000 rubles. Revenue in 2012 was 4,019,000 rubles.
The gross profit margin on sales is 52.6%.
Thus, we can conclude that each ruble earned contains 52.6% of the gross profit.
Operating return on sales = (Profit before tax / Revenue) x 100%
Operating return on sales is the ratio of profit before taxes to revenue, expressed as a percentage.
Indicators for calculating operating profitability are also taken from Form No. 2 “Profit and Loss Statement”.
Operating return on sales shows what part of the profit is contained in each ruble of revenue received minus interest and taxes paid.
For example, profit before tax in 2012 is 2,001,000 rubles. Revenue in the same period amounted to 4,019,000 rubles.
Operating return on sales is 49.8%.
This means that after deducting taxes and interest paid, each ruble of proceeds contains 49.8% of profit.
Return on sales by net profit = (Net profit / Revenue) x 100%
Return on sales based on net profit is calculated as the quotient of net profit divided by revenue, multiplied by 100%.
Indicators for calculating return on sales based on net profit are contained in Form No. 2 “Profit and Loss Statement” (new name “Financial Results Statement”).
For example, Net profit in 2012 is equal to 1,983,000 rubles. Revenue in the same period amounted to 4,019,000 rubles.
Return on sales based on net profit is 49.3%. This means that in the end, after paying all taxes and interest, 49.3% of profit remained in each ruble earned.
Cost-benefit analysis
Return on sales is sometimes called the rate of profitability, because return on sales shows the share of profit in revenue from the sale of goods, works, and services.
To analyze the coefficient characterizing the profitability of sales, you need to understand that if the profitability of sales decreases, this indicates a decrease in the competitiveness of the product and a drop in demand for it. In this case, the enterprise should think about carrying out activities to stimulate demand, improving the quality of the product offered, or conquering a new market niche.
Within the framework of factor analysis of profitability of sales, the influence of profitability on changes in prices for goods, works, services and changes in their costs is considered.
To identify trends in changes in sales profitability over time, you need to distinguish the base and reporting periods. As a base period, you can use the indicators of the previous year or the period in which the company made the greatest profit. The base period is needed to compare the obtained return on sales ratio for the reporting period with the ratio taken as a basis.
Profitability of sales can be increased by increasing prices for the range offered or reducing costs. For acceptance the right decision the organization should focus on such factors as: the dynamics of market conditions, fluctuations in consumer demand, the possibility of saving internal resources, assessment of the activities of competitors and others. For these purposes, tools of product, pricing, sales and communication policies are used.
The following main directions for increasing profits can be identified:
- Increase in production capacity.
- Product quality management.
- Development of marketing policy.
- Cost reduction.
- Staff motivation.
Using the achievements of scientific progress requires capital investment, but allows you to reduce the costs of the production process. Existing equipment can be upgraded, which will lead to resource savings and increased operational efficiency.
High-quality products are always in demand, therefore, if the level of return on sales is insufficient, the company should take measures to improve the quality of the products offered.
Marketing strategies are focused on product promotion based on market research and consumer preferences. Large companies create entire marketing departments. Some enterprises have a separate specialist who is involved in the development and implementation of marketing activities. In small organizations, the responsibilities of a marketer are assigned to managers and other specialists in management departments. requires significant costs, but its successful implementation leads to excellent financial results.
The cost of the proposed product range can be reduced by finding suppliers who offer products and services cheaper than others. Also, while saving on the price of materials, you need to ensure that the quality of the final product offered for sale remains at the proper level.
Human resource management is a separate sector management activities. The production of quality products, the reduction of defective products, and the sale of the final product to a certain extent depend on the responsibility of employees. In order for employees to perform their job duties efficiently and quickly, there are various motivational and incentive strategies. For example, bonuses for the best employees, holding corporate events, organizing corporate press, etc.
Summarizing the above, readers of MirSovetov can conclude that profit and profitability indicators are the main criteria for determining the effectiveness of the financial and economic activities of an enterprise. In order to improve the financial result, it is necessary to evaluate it, and based on the information received, analyze which factors are hindering the development of the organization as a whole. Once the existing problems have been identified, you can move on to formulating the main directions and activities in order to increase the company's profits.
Profit is the main thing. Of course, there are people who disagree with this. Some argue that liquidity and cash flow are more important (and too often ignored). But no one will deny that it is necessary to monitor a company's profitability to ensure its financial health.
There are several ratios you can look at to assess whether your company can generate revenue and control its expenses.
Let's start with return on assets.
What is return on assets (ROA)?
In the very in a broad sense, ROA is the ultra version of ROI.. Return on assets tells you what percentage of each dollar invested in the business was returned to you as profit.
You take everything you use in your business to make a profit - any assets such as money, fixtures, machinery, equipment, vehicles, inventory, etc. - and compare all this with what you did during this period in terms of profit.
ROA simply shows how effectively your company uses its assets to generate profits.
Take the infamous Enron. This energy company had a very high ROA. It was due to what she created individual companies and “sold” my assets to them. Since its assets were thus taken off the balance sheet, the company appeared to have a higher return on assets and equity. This technique is called "denominator control".
But "denominator management" is not always a scam. In fact, it's a smart way to think about how to run a business.
How can we reduce assets so that we can increase our ROA?
You're essentially figuring out how to do the same job at a lower cost. You may be able to restore it instead of throwing away money on new equipment. It may be a little slower or less efficient, but you will have lower assets.
Now let's look at return on equity.
What is return on equity (ROE, from the English. Return on Equity)?
Return on equity is a similar ratio, but it looks at equity - the net worth of the company, measured according to the rules accounting. This metric tells you what percentage of profit you are making for each dollar of capital invested in your company.
This is an important ratio no matter what industry you're in, and is more relevant than ROA for some companies.
Banks, for example, receive as many deposits as possible and then lend them out at a higher interest rate. Typically, their return on assets is so minimal that it is truly unrelated to how they make money.
But every company has its own capital.
How to calculate return on equity?
Like ROA, this is a simple calculation.
net profit/equity = return on equity
Here's an example similar to the one above, where your profit for the year is $248 and your capital is $2,457.
$ 248 / $ 2,457 = 10,1%
Again, you may be wondering, is this a good thing? Unlike ROA, you want ROE to be as high as possible, but there are limits.
This can be explained by the fact that one company may have a higher ROE than another company because it has borrowed more money and therefore had more debt and proportionately less investment put into the company. Whether this is positive or negative depends on whether the first company uses its borrowed money wisely.
How do companies use ROA and ROE?
Most companies look at ROA and ROE in conjunction with various other profitability measures such as gross profit or net profit. Together these numbers give you general idea about the health of the company, especially in comparison with competitors.
The numbers themselves aren't that useful, but you can compare them to other industry results or to your own results over time. This trend analysis will tell you which direction your company's financial health is heading.
Often investors care about these ratios more than managers within companies. They look at them to determine whether they should invest in the company. This is a good indicator of whether the company can generate profits that are worth investing in. Likewise, banks will look at these figures to decide whether to lend to the business.
Managers in some industries find ROA more useful in decision making. Since this indicator reflects the profit generated from the main activity, it can be used by industrial or manufacturing companies to measure efficiency.
For example, construction company can compare its ROA with competitors and see that the competitor has the best ROA, even despite high profits. This is often the decisive push for these companies.
Once you've figured out how to make more profit, you figure out how to do it with fewer assets.
ROE, on the other hand, is more relevant to the board of directors than to the manager, which has little influence on how much stock and debt the company has.
What mistakes do people make when using ROA and ROE?
The first caveat is to remember that none of these numbers are completely objective. Sales are subject to revenue recognition rules. Costs are often a matter of estimation, if not guesswork. Assumptions are built into both the numerator and denominator of the formulas.
Thus, earnings reported on the income statement are a matter of financial art, and any ratio based on these figures will reflect all of these estimates and assumptions. The ratio is still useful, just remember that estimates and assumptions will always change.
Another problem is that you are using a number obtained over a period of time (profit for last year) and comparing it with a number at a certain point in time (assets or capital). It's usually wise to take an average of assets or stocks so that "you're not comparing apples and oranges."
With ROE, you also have to remember that equity is book value. The true cost of capital is the market capitalization of a company's shares. When you interpret this figure, keep in mind that you are looking at book value and market value may be different.
The risk is that since book value is typically lower than market value, you may think you're getting a 10% ROE when investors think your return is much less.
You probably won't make an investment decision based on just one of these numbers, or even both of them. They are part of a larger group of indicators that help you understand the overall health of your business and how you can influence it.