9.6 Analyzing Assets

Question 1

The presentation of financial statement information about long-lived assets allows decision-makers to analyze a company’s use of its total assets. We will use two ratios to analyze assets: the return on assets and asset turnover. We will also show how the profit margin relates to both.

Answer 1

The presentation of financial statement information about long-lived assets allows decision-makers to analyze a company’s use of its total assets. We will use two ratios to analyze assets: the return on assets and asset turnover. We will also show how the profit margin relates to both.

Question 2

return on assets ratio

Answer 2

-measures profitability
Return on assets is calculated by dividing net income by average total assets. (Average total assets are calculated by adding the beginning and ending total assets together, and dividing by 2.

Return on assets indicates the amount of net income generated by each dollar invested in assets. The higher the return on assets, the more profitable the company is (see Decision Tool).

Question 3

return on assets formula

Answer 3

net income/ avg total assetss

Question 4

asset turnover ratio

Answer 4

The asset turnover ratio indicates how efficiently a company uses its assets; that is, how many dollars of sales are generated by each dollar invested in assets.Asset turnover is calculated by dividing sales by average total assets.When we compare two companies in the same industry, the one with the higher asset turnover ratio is generally perceived to be operating more efficiently because it is generating more sales for every dollar invested in assets(see Decision Tool).

Question 5

asset turnover formula

Answer 5

sales/avg total assets

Question 6

profit margin

Answer 6

For a complete picture of a company’s profitable management of its assets, we need to consider a company’s profit margin ratio. In Chapter 5, you first learned about the profit margin.Profit margin is calculated by dividing net income by sales.It tells how effective a company is in turning its sales into income; that is, how much net income is generated by each dollar of sales.Together, the profit margin and asset turnover explain the return on assets ratio. Illustration 9.38 shows how we can calculate the return on assets by multiplying the profit margin by the asset turnover ratio for Cargojet in 2021

Question 7

You can see the mathematical connections in Illustration 9.38. However, if you multiply 22.0% by 0.6, you get a result of 13.2% and not 12.3%. This is simply because of rounding differences—we have chosen to present results rounded to one decimal place in this text. If you use unrounded numbers in your calculations, this equation works perfectly.The relationship of asset turnover and profit margin to the return on assets has important implications for management. FromIllustration 9.38, we can see that, if a company wants to increase its return on assets, it can do it in two ways:Increase the margin it generates from each dollar of goods that it sells (profit margin).Increase the volume of goods or services that it sells (asset turnover).Let’s evaluate Cargojet’s return on assets for 2021 again, but this time by evaluating the ratio’s components: the profit margin and asset turnover ratios. Cargojet had a significant increase in its profit margin in 2021 while having an unchanged asset turnover. We now know that it was the profit margin that was the major driver for the company’s large increase in its return on assets in 2021.

Answer 7

You can see the mathematical connections in Illustration 9.38. However, if you multiply 22.0% by 0.6, you get a result of 13.2% and not 12.3%. This is simply because of rounding differences—we have chosen to present results rounded to one decimal place in this text. If you use unrounded numbers in your calculations, this equation works perfectly.The relationship of asset turnover and profit margin to the return on assets has important implications for management. FromIllustration 9.38, we can see that, if a company wants to increase its return on assets, it can do it in two ways:Increase the margin it generates from each dollar of goods that it sells (profit margin).Increase the volume of goods or services that it sells (asset turnover).Let’s evaluate Cargojet’s return on assets for 2021 again, but this time by evaluating the ratio’s components: the profit margin and asset turnover ratios. Cargojet had a significant increase in its profit margin in 2021 while having an unchanged asset turnover. We now know that it was the profit margin that was the major driver for the company’s large increase in its return on assets in 2021.