Definition
The earned assets to total assets ratio is a formula commonly used by banks to evaluate the proportion of a company’s assets that actively generate income. This ratio provides the bank – or any individual investor – with insight into the likelihood of the company making a profit.
How to Calculate the Ratio
Divide the average earned assets for a specified period (usually the last two years) by the average total assets for the same period.
How the Ratio Works
For example: Lance loves to invest money to generate passive income. He enjoys working, but collecting profits, interest, and rent is one of the greatest joys of his life. He starts the year with $100,000 in bonds, $250,000 in stocks, $250,000 in rental properties, $50,000 in cars, $300,000 in personal residence, and $75,000 in personal assets. Throughout the year, he saves $80,000. He invests it all in additional stocks, raising his total new stocks to $330,000.
Let’s find Lance’s earned assets to total assets ratio. Start by separating earned assets from non-earned assets. Then add the total of all assets at the beginning of the year:
Beginning year assets = $600,000 ($100,000 in bonds + $250,000 in stocks + $250,000 in rental properties)
Total assets at the beginning of the year = $1,025,000 ($100,000 in bonds + $250,000 in stocks + $250,000 in rental properties + $50,000 in cars + $300,000 in personal residence + $75,000 in personal assets)
Next, calculate the same figures at the end of the year:
Ending year assets = $680,000 ($100,000 in bonds + $330,000 in stocks + $250,000 in rental properties)
Total assets at the end of the year = $1,105,000 ($100,000 in bonds + $330,000 in stocks + $250,000 in rental properties + $50,000 in cars + $300,000 in personal residence + $75,000 in personal assets)
Put it into the formula to find the earned assets to total assets ratio:
Step one: ($600,000 + $680,000) ÷ 2 ÷ ($1,025,000 + $1,105,000) ÷ 2
Step two: $1,280,000 ÷ 2 ÷ $2,130,000 ÷ 2
Step three: $640,000 ÷ $1,065,000
Step four: = 0.60 or 60%
Of the assets listed vertically for Lance, 60% earn him money, equivalent to $0.60 for every dollar he owns. In other words, this capital works 24 hours a day, seven days a week, 365 days a year on his behalf. The higher the ratio, the more efficiently the company’s assets are being utilized, or the greater your passive income.
Limitations of the Earned Assets to Total Assets Ratio
This ratio provides important insight into how much of the assets in your portfolio are working to earn you daily income. But keep in mind the value of non-earned assets. A stock portfolio filled with dividend-paying stocks, for example, would be unbalanced. While it puts cash in your pocket, each dividend payment reduces the long-term value of the stock.
Those cash payments are money not reinvested in the company’s growth. This can limit its potential to earn in the long term. Companies that continue to reinvest profits into new growth can significantly expand over time. Keep that in mind when choosing your stocks.
What is the appropriate earned assets to total assets ratio for you? This depends entirely on your needs for passive income versus expectations for long-term returns.
Source:
https://www.thebalancemoney.com/calculate-earning-assets-to-total-assets-ratio-357500
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