Cash return on assets definition
/What is the Cash Return on Assets?
Cash return on assets measures the proportional net amount of cash spun off as the result of owning a group of assets. The measure is commonly used by analysts to compare the performance of businesses within the same industry, since it is very difficult for someone to obfuscate the cash flow figure. Thus, the ratio is quite a reliable and comparable measure of asset performance across an industry. A high percentage of cash return on assets is especially necessary in an asset-heavy environment (such as any manufacturing industry), where the cash is needed to maintain, update, and invest in additional assets.
The cash return on assets is especially valuable when there is a notable difference between cash flows and reported net income, as can sometimes be the case when the accrual basis of accounting is used. In this situation, calculating the return on total assets can be misleading, so cash flow is used instead of the net income figure.
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How to Calculate Cash Return on Assets
The measure is usually derived in aggregate for an entire business, in which case the calculation is to divide the total average assets into the cash flow from operations. The formula is as follows:
Cash flow from operations ÷ Total average assets = Cash return on assets
In the calculation, the cash flow from operations figure comes from the statement of cash flows. The denominator includes all assets stated on the balance sheet, not just fixed assets.
Example of the Cash Return on Assets
The board of directors is concerned about the ability of their company, Frogmorton Industries, to generate cash. They know that the industry average is a 20% cash return on assets, and they do not believe that management is generating a return in that range. They find that Frogmorton’s cash flow from operations in the past year was $2 million, while its total average assets were $20 million. This results in a cash return on assets of 10% (calculated as $2 million cash flow from operations ÷ $20 million total average assets). It appears that management is indeed operating the business at a fairly inefficient level.
Advantages of the Cash Return on Assets
Here are the key advantages of using the cash return on assets measurement:
Avoids accrual accounting distortions. The measurement focuses on operating cash flow, which is less susceptible to accounting manipulations than net income.
Better reflects liquidity. By emphasizing actual cash generated, the measurement highlights a company's ability to sustain operations and meet obligations.
Comprehensive view of asset efficiency. The measurement evaluates how well a company uses its total assets to generate cash, providing insights into operational efficiency. It considers all assets, whether financed by debt or equity, offering a broader perspective than equity-focused metrics.
Early indicator of financial health. A high outcome indicates that a company is generating sufficient cash to reinvest in growth or pay down debt. This helps investors understand if a company has enough liquidity to weather economic downturns or operational challenges.
Aligns with shareholder interests. Investors value cash flow for dividends, buybacks, and reinvestment opportunities. This measurement directly connects operational performance with these outcomes.
Easy to calculate and understand. Operating cash flow and total assets information are readily available from financial statements. Also, it is straightforward to grasp the concept of how well a company is turning assets into cash.
In short, cash return on assets is a robust and reliable metric for assessing a company's operational cash efficiency, offering clear advantages over accrual-based measures and enabling better financial decision-making for stakeholders.