Welcome to week 18 of our 2020 #BusinessChallenge and week 3 of our Assets theme.
Last week we discussed the value-adding asset register and the division of your assets into the 3 categories needed to understand whether your assets are useful or useless.
Return On Assets (ROA)
This accounting ratio is probably one of the most important ratio’s to calculate, for any size business.
It is also probably one of the most forgotten about ratios. It is not measured consistently nor regularly as it should be by SME’s.
The accounting ratio is calculated as follows:
ROA = Net Income (EAITDA) / Total Assets
The higher the ratio, the better the company used its assets to generate an income.
This ratio can then be used to compare yourself to other companies in the industry to determine whether you are utilising your assets better to generate profits than your peers.
Now for an SME it is rather difficult to do this as the financial statements of your peers are not readily available.
So, let’s put a twist on it!
Because the financial statements of your peers are not available, I want you to measure the ROA for each of your assets.
Yes, yes I know. It might not be possible for each desk, chair, hand grinder or wrench.
But let’s be realistic about it.
If you are a courier company, you can determine the turnover or profits per each delivery vehicle.
If you are a widget manufacturer (think back to week 2), then you can calculate the turnover or profits per production machine with relative ease.
See, its not that difficult right.
Also, this exercise is not useful for assets which are going to be sold, or assets which need repairs to be useful.
This exercise only works properly for the assets which are directly generating turnover or profits.
Homework for this week
Look at your value-adding asset register and highlight the assets for which you wish to measure the ROA.
Determine how much profit or turnover each one generated for the business and divide this figure by the value of the asset.
In order to make historic comparisons more accurate, the best is to always use the original cost of the asset. This ensures that you make accurate comparisons over the period for which you have had the asset.
If you however wish to check whether the ROA is above your target range, then use the value of the asset.
The reason for this is that as time goes on, the asset has been utilised to its max every year and its production or income-generating abilities have reduced over the years.