Chapter 19, Problem 5PS

Summary Introduction

To Discuss:

The reason for lower ROA in spite of higher return on sales

Introduction:

Return on total Assets:

The Return on total assets is profitability ratio that measures the percentage of profit earned on average assets invested in the business. Return on asset is calculated by dividing the net income by average total assets. The formula to calculate Return on assets is as follows:

  $\text{Return on assets = }\frac{\text{Net income}}{\text{Average Total Assets}}$

Note: Average total assets are calculated as an average of beginning and ending total assets. The formula to calculate the average total assets is as follows:

  $\text{Average total Assets = }\frac{\left(\text{Beginning total assets + Ending total assets}\right)}{\text{2}}$

Return on total Assets ratio can be broken into its components as follows:

Profit Margin Ratio:

Profit Margin Ratio is a profitability ratio that represents the percentage income earned on the sales. It is calculated by dividing the Net Income by the Sales. The formulas to calculate the Profit margin is as follows:

  $\text{Profit Margin = }\frac{\text{Operating Income}}{\text{Sales}}$

Asset Turnover Ratio:

Asset Turnover Ratio is an efficiency ratio that represents the sales earned on the average assets invested in the business. It is calculated by dividing the Sales by Average total assets. The formulas to calculate the Asset Turnover Ratio is as follows:

  $\text{Asset Turnover Ratio = }\frac{\text{Sales}}{\text{Average total assets}}$