What Is the Earning Assets to Total Assets Ratio?

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DEFINITION

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.

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 they will be for producing wealth. Learn how to use this formula to assess your own wealth potential.

Definition and Examples of 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 create wealth. However, you must know the difference between earning and non-earning assets to understand what this means.

  • 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; copyrights and patents that bring in licensing fees; and machinery that enables you to produce goods for sale at a profit.
  • Non-earning assets: These do not generate income for the owner. A car is an example of a non-earning 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's balance sheet or your stock portfolio. Then, categorize each asset as earning or non-earning.

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

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 asset type, choose the starting balance and ending balance for whatever period you select—most commonly, two-year periods are used. In that case, you would add the assets at the end of last year plus those at the end of this year and then divide by two.

How the Earning Assets to Total Assets Ratio Works

Here's an example: Lance likes to invest 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 the earning assets from the non-earning 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)

Next, 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%

Of the assets on Lance's balance sheet, 60% are earning money for him, equal to $.60 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 non-earning assets. A stock portfolio full of only dividend-paying stocks, for instance, would be out of balance. While putting cash in your pocket, every dividend payment 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 used to evaluate the proportion of actively earning financial assets.
  • The ratio can help you evaluate how effectively your portfolio generates passive income.
  • A balanced portfolio will earn income for an investor in dividends now, and in long-term capital gains for the future.
  • The best earning assets to total assets ratio depends on your passive income needs vs. your long-term return expectations.