Increasing or maintaining return on assets is one of the most important tasks that need to have serious attention from senior management of most of the big corporate companies.
This is because of this ratio interested by the majority of shareholders, prospective investors, the board of directors, management team themselves, as well as staff.
Yet, group of stakeholders who mostly concern about return on assets are shareholders.
These people want to know how efficiently the senior management of corporation manage their assets.
The higher ratio simply means the assets are well managed and low ratio means the resources do not use efficiency compare to the industry as well as competitors.
The following are the four critical points that management of the company should fix to get the return on assets high or increase to the target points:
Get the idea from Formula:
Return on Assets = Net Income / Total Assets
+ Net income is the net earning for the period of time that we want to assess ROA. We can get the figure from income statement.
+ Total Assets or average of total assets are the net present value of assets at the end of the period. We also can get this figure from balance sheet.
Based on the formula, there are two items that affect ROA ratio, Net income and Total Assets
Improve net income will increase the return on assets ratio, right? And the decrease in total assets will also affect the ratio.
1) Increase Net income to improve ROA:
There are many ways that an entity could increase its net income. For example, the entity could increase total sales for the period, then net income will increase accordingly.
Let sales if 1000K of sales contribute to 10K net income then increase sales ratio will also increase net income ratio and do so ROA.
The cost of goods is one of the most major costs that significantly affect net income. And keep the direct cost low is one of the most effective strategies that could improve gross profit margin as well as net income.
The entity might choice to increase the production volume to reduce direct cost of products.
Entity might also need to review the operating costs to make sure that cost are spending effectively.
For example, if the net profit ratio is 25%. 1$ save equal to 4$ sales. This explanation proves that keep operating costs low is as important as keeping sales increase.
Therefore, increasing net income is very important if the entity wants to increase ROA. And to increase net income, entity should strictly review sales, cost of sales, and operating cost.
2) Decrease Total Assets to improve ROA:
As we mention above, ROA is the ratio that assesses the efficiency of using assets. In others, it compares how much entity generates income from 1$ of assets compare to other entities or industry averages.
Now, let breakdown what does it mean by efficiency of using assets.
As you should know, assets are the balancing items in the balance sheet. Assets equal to equity plus liability. Accounting standards classify those assets into current and fixed assets for user benefit.
Now let breakdown those assets and analyst what does it mean by efficiency of assets.
3) Improve the efficiency of Current Assets:
Current assets consist of cash, receivable as well as inventories. The efficiency of using these assets could keep them low or let them generate additional income.
For example, an entity might make short term investments on cash to generate additional incomes. This will help ROA.
Receivables are also one of the most important current assets that an entity could manage to improve its ROA when they are low and short outstanding. Good credit policy and collection procedures could significantly help to improve this.
4) Improve the efficiency of Fixed Assets:
Expenses on fixed assets are not charged to income statements at the time they are purchased, but at times they are used based on the system basic.
Improve efficiency ratio on using fixed assets could help the company increase its productivity or in other words, reduce operating costs related to fixed assets.
Some companies consider operating lease rather than purchasing their own fixed assets. However, this approach might lead to higher operating costs.
Improving return on assets is an important key performance indicator for the management team of most of the entities. And there are many ways that management could perform to make its ROA better.
Those include increase gross profit margin, net profit margin, as well as improve the efficiency of both current assets and fixed assets.