25% = Return on your assets
1 Apr, 2003 By: Kevin Kehoe LDB SolutionsReturn on assets is a better business indicator than net profits
How healthy is your business? Return on assets is the real test, not net profits. Based on the risk associated with owning a seasonal small business, 25% is the minimum you should expect from your business investment. Of course you want a higher percentage than this, and in fact there are some very successful companies in the industry who achieve as high as a 50% return on their assets. However 25% is the minimum target.
 Return on assets example calculation |
Return on assets is a ratio. It is calculated by dividing your net profits before taxes (from your income statement) by your total average assets (from your balance sheet). See example above.
Why is this number important?
First, it's important because it tells whether you are using your assets efficiently. You see, the same net profit may yield a very different return on assets.
For example, let's compare two companies doing $1,000,000 in annual sales. Company A earns a 10% net profit, and Company B earns 9%. Which is performing better? At first blush, Company A seems to be better off. However, if we consider the assets invested by each, the picture changes.
Let's say that company A has $400,000 of invested in assets and company B has $300,000. Company A's return on assets is 25% ($100,000 divided by $400,000). Company B's return on assets is 30% ($90,000 divided by $300,000). Company B is doing more with less - earning the owner a better total return on investment.
Return on investment is also important because it can be used as a benchmark to set minimum and maximum capital spending limits. This is a good thing in an industry where we love our toys and don't always consider whether they are earning a proper return. Increase your assets only as fast as they yield a 25% return rate.
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