Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

14. Financial Statement Analysis

1

Ratios: Cash Return on Assets

3m

Play a video:

Was this helpful?

Alright, let's dive into another ratio here, the cash return on assets. So cash return on assets, it's very similar to the return on assets. When we talked about return on assets. While we're talking about the net income that we got compared to the average total assets. Well, here, we're gonna strictly think about cash. So we're gonna be focused on the cash flows rather than net income. So we're gonna be looking at the operating cash flows specifically based on the amount of assets that we maintain. So you can imagine that it's better if we're gonna make, let's say $1 million $1 million $10 million dollars worth of assets. Right? The less assets we need to make the same amount of money the better. Right. So that's kind of like an efficiency thing. So let's check out the cash return on assets. The formula here notice in our numerator, we've got our operating cash flows. So these operating cash flows, they come from the statement of cash flows, they come from the statement of cash flows, where we show on the statement of cash flows. We we have three sections, we have the operating cash flows, which is these numbers that we're looking from here. Operating cash flows. Well, that's our operations, right from actually running our business. How much cash flow did we generate, then there's the investing section. So we've got operating, then we've got investing, which is dealing with buying and selling fixed assets, long term assets. And then the last section is the financing section, which is where we're dealing with long term liabilities with the banks as well as with our shareholders. The equity. Okay, So we're focused on that first section on the statement of cash flows for our operating cash flows. And then our denominator, we've got average total assets. Remember when we do an average, we're always it's gonna take the beginning balance plus the ending balance and then divide by two. Right? So beginning balance and this is every time we do an average balance, it's always going to be like this beginning balance plus ending balance divided by two. Now, if they just give you one number for total assets, well, that's what you're going to use. Okay, that will be your total assets. So this is pretty simple, not too much going on there. And one more thing about this ratio is that we do generally show it as a percentage. Okay, so whatever you get there, you're gonna have to multiply it by 100. Move the decimal to places. You know, do what you gotta do to get it into percentage form. All right. So how do we analyze this ratio? What is it telling us? Well, remember it's how much of the numerator for each of the denominator. Okay, so the numerator being operating cash flows will tell us how much operating cash flows we get for each dollar of assets that we maintain. Okay, so that's what this is gonna tell us. So, well, when we have a negative cash return on assets, this could be a red flag for the company, because how could we have a negative ratio here? Well, we couldn't have negative total assets, Right. But we could have negative operating cash flows if we didn't bring in as much cash as we had to pay during the period. Right? So if we had a net cash outflow, I'd say, a net outflow and I'm gonna put cash outflow, a net cash outflow from operating activities. Well, we would have a negative ratio here. Okay, so you want to do a little more analysis to make sure why are we having negative cash flows from operating activities? Cool. So this isn't the craziest ratio here? Why don't we dive in and do some practice problems right now?

2

Problem

XYZ Company had net sales during the period of $380,000 and operating cash flows of $60,000. If total assets were $480,000 at the beginning of the period and $720,000 at the end of the period, what is the company’s cash return on assets?

A

8%

B

10%

C

13%

D

63%

3

Problem

A company has income before taxes of $120,000. Net sales are $400,000 and gross profit is $300,000. Operating cash inflows totaled $360,000 and operating cash outflows totaled $300,000. What is the cash return on assets, assuming the company has a 40% tax rate, and average total assets were $900,000?

A

6.7%

B

11.1%

C

33.3%

D

44.4%

© 1996–2023 Pearson All rights reserved.