Making a profit? Great! But don’t forget that the comparison that matters is on the balance sheet. Here’s what to look for…
Return on total assets
In last week’s column we discussed whether your assets were working hard enough. After all, they soak up a considerable amount of the funds within your business, so they had better perform.
The sole purpose for the assets of your business is to generate a return to that business and in this competitive world the name of the game is to generate the biggest return with the least amount of assets.
Therefore as always, it is very important that the reward for effort, in this case, the return (profit) generated by the assets of the business, is measured and managed against that effort (assets) to answer the important question: “Is it worth it?”.
Visually, the comparison looks like this:
We compare the return for the year (or period) against the value of the assets that produced that return.
This type of analysis is often referred to as “return on total assets” (ROTA). As a formula, ROTA looks like this:
So in the example above, even though they have made an after-tax profit of just over $1 billion, this business is only returning 7.7% on the funds invested in its assets ($13.3 billion). Whether that is considered good, bad or otherwise will of course depend on the specific circumstances of the business, a comparison against its competitors and also industry results. Would you, as a potential shareholder/investor be interested in a business returning 7.7% on its assets?
For example, if the business had just acquired some significant assets, say another business, it may take some time before it can get those assets performing effectively and efficiently, and thereby generate the expected return.
Alternatively, the assets may not be appropriate any more (consider value, quality, life-cycle, obsolescence, location etc) and strategic decisions may need to be made.
One of the good things about the internet is the relative ease of collecting statistical data to compare yourself against. Good old Google will provide you with plenty of businesses offering their (paid) support. You can also visit the Australian Bureau of Statistics website, the Australian Government Parliamentary Library, the Reserve Bank and the various industry bodies who maintain statistical data.
Business owners sometimes forget to focus on their balance sheet. Hitting a sales target is wonderful and a profit looks great in the income statement, but what about when compared to the balance sheet?
What should your balance sheet look like to make your business attractive. That’s the mindset you need to adopt – if all or part of my business were for sale today, would it be attractive?
Not all assets are financial assets. What about your systems and processes? Are these “assets” of your business, pulling their weight and thereby adding value?
Mark Robilliard and business partners Peter Frampton and Carmen Mettler started a journey to find a new way for anyone to ‘get accounting’ and use it in their job and life to create value. Accounting Comes Alive was born and now provides workshops all over the world using their unique Colour Accounting™ learning system that really does work, for anyone.
To read more Mark Robilliard blogs, click here.