What Is the Earning Assets to Total Assets Ratio?

How to Calculate the Earning Assets to Total Assets Ratio

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The earning assets to total assets ratio is a formula that banks commonly use to evaluate the proportion of a company's assets that are actively generating income. It provides the bank—or any individual investor—with insight into how likely the company is to generate a profit.

Investors can use the earnings assets to total assets ratio to evaluate their investment portfolios and determine how effective it will be for producing wealth. Learn how to use this formula to evaluate your own wealth potential.

What Is the Earning Assets to Total Assets Ratio?

You can use the earning assets to total assets ratio formula to see what percentage of assets in a company or stock portfolio are creating wealth. To understand what this means, however, you must know the difference between earning and nonearning assets.

  • Earning assets: These are assets that directly generate income. They might include stocks that pay dividendsbonds that pay interest; real estate properties that generate rental income; copyright and patents that bring in licensing fees; and machinery that enables you to produce goods for sale at a profit.
  • Nonearning assets: These do not generate income for the owner. A car is an example of a nonearning asset because it only drains money from your life. That's likely true unless you own a delivery service or drive for Uber. Stocks that aren't paying dividends would be another type.

Once you know these key differences, go through a company balance sheet or your stock portfolio. Then, categorize each asset as earning or nonearning.

How Do You Calculate the Earning Assets to Total Assets Ratio?

Here's how to calculate the earning assets to total assets ratio: Simply divide the average of the earning assets for a specific period (usually the last two years) by the average total assets for the same period.

Earnings assets to total assets ratio

To get the average for each of the asset types, just choose the starting balance and ending balance for whatever period you choose. It's common to look at a two-year period. In this case, you would add the assets at the end of last year plus those at the end of this year; then, divide by two.

How the Earning Assets to Total Assets Ratio Works

Here's an example: Lance likes to invest his money to produce passive income. He enjoys working. But collecting dividends, interest, and rents is one of the great joys in his life. He starts the year with $100,000 in bonds, $250,000 in stocks, $250,000 in rental property, $50,000 in cars, $300,000 in a personal residence, and $75,000 in personal assets. During the year, he saves $80,000. He invests it all in additional stocks, bringing the new stock total to $330,000.

Let's find Lance's earning assets to total assets ratio. Begin by separating out the earning assets from the nonearning assets. Then, add up the total of all assets as of the beginning of the year:

  • Beginning year earning assets = $600,000 ($100,000 in bonds + $250,000 in stocks + $250,000 in rental property)
  • Beginning year total assets = $1,025,000 ($100,000 in bonds + $250,000 in stocks + $250,000 in rental property + $50,000 in cars + $300,000 in personal residence + $75,000 in personal assets)

Now, calculate the same numbers at the end of the year:

  • Ending year earning assets = $680,000 ($100,000 in bonds + $330,000 in stocks + $250,000 in rental property)
  • Ending year total assets = $1,105,000 ($100,000 bonds + $330,000 in stocks + $250,000 in rental property + $50,000 in cars + $300,000 in personal residence + $75,000 in personal assets)

Put them into the formula to find the earning assets to total assets ratio:

Step One:

($600,000 + $680,000) ÷ 2
--------- divided by ---------
($1,025,000 + $1,105,000) ÷ 2

 Step Two:

($1,280,000) ÷ 2
--------- divided by ---------
($2,130,000) ÷ 2

Step Three:

$640,000
--------- divided by ---------
$1,065,000

Step Four:

= 0.60, or 60%

This tells us that 60% of the assets on Lance's balance sheet are earning money for him; this is equal to 60 cents of every dollar he holds. In a very real sense, that capital is out there working 24 hours a day, seven days a week, 365 days a year on his behalf. The higher the ratio, the more efficient the use of assets in a company or the more passive income your money is making you.

Limitations of the Earning Assets to Total Assets Ratio

This ratio provides an important look at how much of your portfolio is working to earn you income each day. But remember the value of nonearning assets. A stock portfolio full of only dividend-paying stocks, for instance, would be out of balance. Every dividend payment, while putting cash in your pocket, decreases the long-term value of the stock.

Those cash payouts are money not reinvested into the company's growth. This can limit its long-range earning potential. Firms that keep reinvesting earnings into new growth can grow immensely over time; keep that in mind as you're choosing your stocks.

What is the right earning assets to total assets ratio for you? It all depends on your passive income needs vs. your long-term return expectations.

Key Takeaways

  • The earning assets to total assets ratio is a formula; it's used to evaluate the proportion of assets that are actively earning money.
  • This can help you evaluate how effective your portfolio is for generating passive income.
  • A balanced portfolio will earn income for an investor in dividends now and long-term capital gains for the future.
  • The right earning assets to total assets ratio for you depends on your passive income needs vs. your long-term return expectations.