Return on Assets Employed

Definition

The term return on assets employed refers to a measure that allows the investor-analyst to understand the return a company is generating relative to the assets they employ. Generally, companies should generate as much profit as possible using a minimum amount of assets.

Calculation

Return on Assets Employed = Net Profit / Assets Employed

Where:

  • Assets Employed = Total Assets - Depreciation, or
  • Assets Employed = Fixed Assets - Depreciation
  • The rationale behind using only fixed assets is these are the assets directly involved in manufacturing the company's products. Analysts will argue that the metric should also include assets like inventory and accounts receivable since these asset classes tie up a lot of cash.

Explanation

Return on investment measures allow the investor-analyst to understand the company's ability to provide investors with an acceptable return on their money. This is usually assessed by examining metrics such as net worth, returns on equity or assets, earnings, economic value added, and dividends. Return on investment metrics provide analysts with a way to determine a fair price to pay for a share of common stock. One of the ways to understand return on investment is by measuring a company's return on assets employed.

An investor-analyst can better understand how well a company utilizes its assets by examining its return on assets employed ratio. The metric is a simple ratio of profit to assets; however, the analyst has several options as to what assets appear in the denominator of this metric. Under nearly all options, assets will be net of depreciation. Some theorists argue the only assets to use are fixed assets since it's important to understand if the company is using their production facilities in an optimal manner. Others argue to include a larger swath of assets such as inventory and accounts receivable, since a company may have a lot of their "cash" tied up in those accounts.

Example

The CFO would like to better understand how well Company ABC is utilizing their fixed assets. The company has a continuous improvement effort already underway to lower inventory and improve accounts receivable. She asked her analytical team to calculate the measure and compare it to an industry peer set, which manages a return of 12.3% on fixed assets. The table below was provided by her team:

  Year 1 Year 2 Year 3
Net Profit $6,676,000 $7,074,000 $7,490,000
Fixed Assets $61,817,000 $63,729,000 $65,700,000
Return on Assets Employed 10.8% 11.1% 11.4%

The CFO was disappointed to see Company ABC still lagging behind its peers, and she order the continuous improvement team to evaluate how to better utilize the assets at each of the company's plants.

Related Terms

return on infrastructure employed, return on operating assets, tangible book value, book value per share