Return on average assets definition

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What is the Return on Average Assets?

The return on average assets measures the efficiency with which a business utilizes its assets to generate a profit. It is most commonly used to measure the performance of financial institutions.

How to Calculate the Return on Average Assets

The return on average assets calculation follows these steps:

  1. Derive the average assets by adding together the beginning and ending book values of all company assets, and dividing by two.

  2. Divide the average assets figure into the net income generated during the measurement period.

Related AccountingTools Courses

Business Ratios Guidebook

The Interpretation of Financial Statements

When to Use the Return on Average Assets

The return on average assets concept works best when comparing businesses within an industry, since each of these competitors probably requires roughly similar amounts of assets to generate a profit. This means that any variances from the industry average are strong indicators of either superior management performance (in the case of a high return on average assets) or of inferior performance (in the case of a low return on average assets).

Disadvantages of the Return on Average Assets

There are several disadvantages to be aware of when using the return on average assets. They are as follows:

  • Negative impact on business heath. Management is usually considered to be doing a better job when it can produce a profit with a reduced asset base. However, an excessive reduction of assets can be detrimental to the health of a business. For example,  management could decide to reduce the number of days that customers are allowed to pay on credit, which reduces the investment in accounts receivable, but may also drive away some customers.

  • Calculation inaccuracy. A problem with the return on average assets is that it assumes the beginning and ending asset figures are representative of the asset levels experienced on a daily basis, which is not necessarily the case. The asset level in some industries can change substantially on a daily basis; if so, it can make sense to compile the average assets figure from the ending balance on every business day.