Return on assets reflects the efficiency of the company's operations and the use of invested capital. Therefore, the drop in this indicator is an alarming signal for business owners.
The concept of return on assets and the reasons for its decline
Return on assets is an indicator that allows you to assess the results of the company's core activities. It shows the return that falls on each ruble of assets, regardless of the source of their formation. It is calculated as the ratio of net profit to the assets of the enterprise.
An integral financial analysis provides a deeper picture of the formation of this indicator. With regard to the efficiency of the use of assets, the company most often uses the financial analysis system developed by DuPont. It involves the decomposition of the formula for the return on assets into several indicators.
According to the model, the return on assets ratio is calculated as the return on sales multiplied by the asset turnover. In this formula, the return on sales is equal to the ratio of net profit to revenue, and turnover is equal to the ratio of revenue to assets.
The use of the DuPont model makes clear two reasons for the fall in return on assets - a decrease in profitability of sales and a decrease in turnover. Considering these indicators in dynamics, it is possible to determine which of them ultimately led to a fall in the return on assets.
Analysis of indicators of return on assets allows you to identify problem points in the business and develop ways to resolve them.
Ways to Improve Your Return on Assets
The main reason for the fall in the profitability of sales (and, accordingly, the profitability of assets) is the increase in the cost of production (sold) products. In this situation, the company needs to focus its own efforts on improving the efficiency of cost management. In particular, to determine the most significant components of the cost of production and identify possible ways to reduce them. This is, for example, the search for new suppliers of raw materials, reduction of energy costs through the introduction of energy efficient technologies, etc.
It is also worth dividing the costs in the cost structure into fixed and variable ones and calculating the break-even point. It may be necessary to conduct a detailed analysis of the assortment matrix and change the range of products.
Another reason for the fall in return on assets may be a drop in sales. This affects the growth of production costs due to an increase in the share of overhead costs in it. If it was revealed that the main negative factors were precisely the drop in sales, the company should focus on marketing, pricing and assortment policies. In particular, it is necessary to assess their own competitive positions in the market in these areas.
It is also possible to increase the return on assets by reducing working capital or fixed assets. It is possible to achieve this goal by selling inefficient equipment or reducing non-production assets; reduction of raw materials and work in progress; as well as reducing accounts receivable. Of course, it is worth considering the liquidity of assets in order not to upset the balance between working capital and the ability to pay off creditors.
