PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Communicating and Interpreting Accounting Information Chapter 5

5-2 Return on Assets  The return on assets ratio relates net income to average total assets. –This ratio combines the firm’s income- generating strength (profit margin) and its revenue-generating effectiveness (asset turnover).

5-3 ROA Profit Driven Analysis ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. ROA Net profit Margin Net Sales Total Average Asset Net Income Net Sales Net Income Average Total Asset Total Asset Turnover

5-4 ROA Net Profit margin : Measure how much of every sales dollars is profit. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. It can increased by :  Increasing sales value.  Increasing sales price.  Decreasing cost of goods sold and operating expenses.

5-5 ROA Total asset Turnover: Measure how many sales dollars the company generate with each dollar of Assets. The Asset Turnover ratio is an indicator of the efficiency with which a company is deploying its assets It can increased by :  Collecting accounts receivable more quickly.  Centralizing distributors to reduce inventory kept on hand.  Consolidation production facilities in fewer factories to reduce the amount of assets necessary to generate each dollar of sale.

5-6 Exercise The following information was taken from the income statement and balance sheet of The Mickey Company for the years 2010 and 2011: Compute the following ratios for 2011: Net profit margin, Asset turnover, and Return on assets.

5-7 Answer Net profit margin = Net income / Net Sales = $2,345 / $30,752 =.076 or 7.6% Asset turnover = Net Sales / Net Average Assets = $30,752 / $51,945* =.59 Return on assets = Net profit margin  Asset turnover Return on assets =.076 X.59 =.045 =4.5 % * Net average assets = $49,988 + $53,902 /2