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Communicating and Interpreting Accounting Information

Communicating and Interpreting Accounting Information. Chapter 5. 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).

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Communicating and Interpreting Accounting Information

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  1. Communicating and Interpreting Accounting Information Chapter 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).

  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 Total Asset Turnover Net Income Average Total Asset Net Income Net Sales Net Sales Total Average Asset

  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. 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.

  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. 

  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

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