What Does Average Total Assets Mean?
Average total assets in accounting mean the average amount of assets of a company employed throughout the year. Average total assets can be calculated by adding the total assets at the start and end of the reporting date and dividing it by 2.
The resultant figure is called average total assets and is used in calculating different financial ratios.
When it comes to analyzing the financial health of a company, one important metric to consider is average total assets. But what does this metric actually measure and why is it important for investors and analysts to understand?
What is the difference between total assets and average total assets?
While total assets refer to the overall value of all assets at a specific point in time, average total assets take into account the total assets over a period of time, such as a fiscal year. This metric is calculated by adding up the total assets at the beginning and end of a period and then dividing that number by two.
Suppose that a company has assets worth 2m at the start of the period and throughout the year new assets are added and some are disposed off. At the end of the reporting date, the company has assets worth 1.5m. To know how many assets were actually employed throughout the year, average total assets are calculated.
That being said, we can say that the term average total assets is an aggregate of the total assets of a company throughout the year or period.
Primarily, the average total assets are calculated to see how well the company has used its resources. If company A has $2m total average assets and its net profit is $200,000 and company B makes the same profit with only $1m average total assets. We can say that company B is more efficient than company A in terms of using its assets.
TOTAL AVERAGE ASSETS FORMULA
The Formula to calculate total average assets is opening assets + closing assets/2. Opening assets are the assets of a company at the beginning of the period or simply closing assets of the previous period carried forward. Closing assets are the assets of a company at the reporting date.
HOW TO CALCULATE AVERAGE TOTAL ASSETS?
A simple way to calculate the total average assets figure is to add the number of assets at the beginning of the period with the number of assets at the reporting date. Divide the sum by 2 to arrive at the average total assets figure. Let me calculate the figure to make it easier for you to understand.
Assets as at 31/12/2022 (closing) = 20,000
Calculate Average Total Assets.
Solution:
Opening Assets + Closing Assets / 2
Putting values,
= 10,000+20,000/2
Average Total Assets = 15,000
In this example, opening assets will be the closing assets of the previous year as the figure will simply be carried forward. That being said, average total assets = 34,500 (13,000+56000/2).
Why is average total assets important?
There are a few key reasons why average total assets is an important metric for investors and analysts to consider.
It can provide insight into a company’s growth
A company that is consistently increasing its average total assets over time is likely growing and expanding its operations. This can be a positive sign for investors, as it indicates that the company is generating more revenue and investing in new opportunities.
It can indicate a company’s liquidity
A company with high average total assets and low liabilities is considered to be financially healthy and has a strong balance sheet. This means that the company has the resources to meet its financial obligations and can withstand economic downturns.
It can be used to compare companies within the same industry
By comparing the average total assets of companies within the same industry, investors and analysts can get a sense of how a specific company is performing in comparison to its peers. This can help identify companies that may be underperforming or overperforming in terms of growth and financial health.
WHY AVERAGE TOTAL ASSETS ARE CALCULATED?
Primarily, the total average asset figure is calculated to see how well a company has used its assets (Return On Assets). Typically, if a company makes higher returns on fewer assets, it’s a good sign, and the company is said to be efficient. However, comparing TWO companies merely on the basis of total average assets isn’t a good idea because of varying industries, size of the companies, differing objectives, etc…
Here’s a brief introduction of return on assets.
RETURN ON ASSETS (ROA)
Return on Assets or Return on Average Assets is a measure of a company’s profitability in relation to its assets. It can be calculated using the formula:- Net Income/Total Average Assets. Where net income = Net Income for the year and Total Average Assets = Opening Assets + Closing Assets divided by 2.
ASSET TURNOVER RATIO
Asset Turnover Ratio is the ratio of total sales (revenue) to average assets. Like ROA, it is an indicator of the efficiency with which the company has used its assets. A higher asset turnover ratio indicates that the company is generating revenues from its assets efficiently and vice versa.
Asset turnover ratio can be calculated by dividing the revenue figure by the average total assets. The formula is given below.
Asset Turnover Ratio= Revenue/Average Total Assets
where average total assets = opening assets + closing assets/2
PROS & CONS
There are some pros & cons of calculating total average assets and comparing TWO companies on the basis of ROA.
PROS
- ROA, which takes into consideration the total average assets, helps in comparing companies that are almost the same size and operating in the same industry. If one company’s returns are higher in respect of its assets, it is considered better. The comparison is fair when the companies are of the same size and operate in the same industry.
- No advanced accounting knowledge is required to calculate total average assets and return on assets.
- Easier to understand for users.
CONS
- ROA is limited to companies of the same size and industry and doesn’t provide value for investors who want to diversify their investments.
- While the ROA may be easier to calculate, it only focuses on profitability and does not provide details about liquidity and gearing.
- Some companies have a lot of assets that are not actively involved in generating returns and including those assets in calculating total average assets would be unfair.
Conclusion
The Average total assets is an important metric for understanding a company’s financial health and growth potential. It provides insight into a company’s liquidity and can be used to compare performance within an industry. Investors and analysts should consider this metric when analyzing a company’s financials.
