Financial Ratios Part 8 of 21: Rate of Return on Assets
What rate of interest did the business provide to its investors this year?
Financial Ratios and indicators can assist in determining the health of a business. There is a minimum of 21 different ratios and indicators that can be looked at by many financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios and indicators must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios and indicators.
Rate of Return on Assets is a measure of Profitability and is determined based on information derived from a business’ or farm operations Income Statement. The term Profitability is the difference between the value of what is produced or service provided and the cost of producing that product or providing that service. The Rate of Return on Assets specifically provides the average interest rate that has been earned on your and the bank’s investments into the business. Unpaid labor and management is assigned a return prior to a return on assets is calculated therefore a value for this must be determined.
The following equation will determine your Rate of Return on Assets:
Rate of Return on Assets = Net Income From Operations + Loan Interest – Value of Operator Labor and Management/Average Farm Investment
Average Investment = (Beginning Total Assets + Ending Total Assets) / 2
Rate of return on assets is measured as a percentage. This is one of those measures that is easy to understand, the larger the number the better the return on all of the investments (owners equity and the financing coming from creditors) into the business. The one question that must be answered by the owner when looking at this number is whether this return is worth the investment of labor, management, and equity when compared to other sources of investment.
If you have any further question please feel free to contact your local Farm Management Educator or the author.
Information for this article has been gathered using material created by the University of Minnesota Center for Farm Financial Management (CFFM)
You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 6: Debt-to-equity ratio
Part 7: Net farm income
Part 9: Rate of return
Part 10: Operating profit margin
Part 11: The EBITDA measurement of profitability
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 14: Replacement margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 20: Interest-expense ratio
Part 21: Net income ratio