Average total assets show the operating efficiency of a business and can be used to compare net income in terms of assets.
It is a commonly used financial metric with a few simple steps to calculate the figure. However, it does come with some limitations as it uses historical data.
Let’s dive into the details of how to calculate average total assets, a working example, and discuss the benefits and limitations of using this figure.
What Are Average Total Assets?
The term average total assets refers to the average of assets held by an entity at the end of two accounting periods.
This calculation can be on a monthly or yearly basis. The most common practice is to take year-end figures of total assets held by an entity in two consecutive years and take the average.
The average total asset figure is then used in different types of analysis like calculating the return on average assets or comparison to sales.
Most entities will use the total assets figure from the balance sheet. However, since established businesses accumulate large cash reserves, they often exclude cash from the total assets figure.
For growing businesses, the practice is to include all types of assets, including:
- Building, Land, and Properties
- Cash and Cash Equivalents
- Goodwill – Copyrights, Patents, and Trademarks
- Accounts Receivable
- Inventory
- Advance Deposits
For accounting practices, an entity can exclude certain items from calculations like goodwill, cash, or receivables to analyze specific performance metrics.
How to Calculate Average Total Assets?
The calculation of average total assets is a simple process. Before you start the calculations, decide on the number of items to be included or excluded if preferred.
Step 01:
The first step is to determine the accounting period, a month or year. Then, take the total assets figure at the end of that accounting period.
This figure can be obtained from the balance sheet at the end of the year.
Step 02:
The second step is to take the total assets figure for the preceding accounting period. You can easily take this figure from the previous year’s balance sheet.
Step 03:
The third and final step is to use the average total assets formula and find the answer.
Average Total Assets = (Total assets for the current year) + (Total assets for the current year) / 2
You simply add both figures calculated in the previous two steps and divide them by 2 to get the answer.
Example
Let’s take a real-world example to calculate the average total assets of Meta (Facebook).
Meta’s total assets for the year ending 2022 = $ 185,727 B
Meta’s total assets for the year ending 2021 = $ 165,987 B
Now, we only have to use the simple formula given below:
Average Total Assets = (Total assets for the current year) + (Total assets for the current year) / 2
Average Total Assets = ($185,727 + $ 165,987) / 2 = $ 351,714 / 2
Average Total Assets = $175,857 B
The average total assets of Meta at the end of 2022 are $175,857 billion.
For the most recent analysis, we can use the figures for 2022 and the latest published figure of Q2 for June 2023.
Meta’s total assets for Q2, June 2023 = $ 206,688 B
Meta’s total assets for the year ending 2022 = $ 185,727 B
Average Total Assets = ($206,688 + $185,727)/2
Average Total Assets = $196,207 B
Why Do Businesses Use Average Total Assets?
The foremost and the most common use of the average total assets figure is to analyze the efficiency of a business.
The Average total assets figure tells shareholders how efficiently a business is managing their provided assets.
The figure is then compared with the total revenue figure for the same period. Comparing sales to average assets provides a clearer picture of the operational efficiency of a business.
However, for better comparisons, both figures for sales and average assets should be considered for the same accounting period.
Businesses can use monthly figures for average assets and revenue as well. It provides an updated picture of the operating efficiency of the business.
Sometimes, a business may use a variant of the simple average assets formula. For instance, a business with a large cash surplus may want to assess the impact of asset utilization without cash.
Similarly, a manufacturing business with a large proportion of inventory in its assets would want to assess the efficiency of other assets for the business by excluding inventory from the calculations.
Variations of Average Total Assets and Relevant Metrics
A key financial metric relevant to the average total assets figure is the return on average assets (ROAA).
Return on average assets compares net income against average total assets. It means it is helpful in analyzing the profitability of a business in terms of its asset utilization.
The formula for the return on average assets is:
ROAA = Income / Average Total Assets
The Average total assets are calculated in the same way as discussed above.
Since we are comparing average total assets with net income, both figures should be taken from the same accounting period.
In that case, average assets should be calculated by using the beginning and ending figures of total assets for that period.
Other variants of the average total assets take place when managers tweak the formula and exclude certain items from calculations like cash, inventory, or goodwill.
Benefits of Using Average Total Assets
The average total assets figure is useful for managers and shareholders in many ways. It helps stakeholders understand the efficient use of the resources allocated for the business.
Asset Allocation
By comparing the asset figures from two consecutive periods or the beginning and ending figures, a business can analyze the asset allocation effectively.
This figure gives an idea of how and where the assets are allocated and how are they increasing or decreasing.
Analysis of Profitability in Terms of Assets
Then, the prime use of the average total assets figure is to assess the profitability of a business in terms of its assets.
In other words, it shows how well a business is utilizing its available resources. A low asset level against a high level of income shows efficient use of the available resources.
A Key Input in Several Types of Analysis
As mentioned above, the average total assets formula has several variants. It is also an integral part of several other financial metrics like ROAA, Debt-to-equity, and asset turnover ratio.
Therefore, calculating the average assets figure can be useful for a business in different ways.
Limitations of Using Average Total Assets
Despite its usefulness and simplicity, the average total assets analysis has several limitations for all stakeholders.
Historic Data Used
Like other financial ratios, it also uses historical data. It means you must wait until results arrive and then assess how a business is performing.
It comes with embedded limitations of using past figures with no forward-looking output from the calculations.
Requires Meaningful Comparison
You need to be careful when comparing past data and must utilize key input data metrics to arrive at meaningful results.
Since the total assets figure for a business comes with several variations, extra care should be taken when analyzing assets and net income.
Also, as with other accounting data, the average total assets figure can be manipulated to showcase favorable results by managers.
Limited Use for Forecasting
Although analyzing past data provides useful insights into a business’s performance, it doesn’t offer much for forecasting.
You must analyze the same financial metrics over a long period to establish trends and then compare them carefully to make forecasts. Despite all the limitations, the average total assets formula can be used in several types of analysis for measuring a business’s asset allocation, profitability, and efficiency.
