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.

Individual investors can use the earnings assets to total assets ratio to evaluate their investment portfolio 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 are those that directly generate income, such as 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 are things that do not generate income for the owner. A car is an example of a nonearning asset because it drains money from your life—unless you own a delivery service or drive for Uber. Stocks that aren't paying dividends would be another example.

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

How to Calculate the Earning Assets to Total Assets Ratio

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 which case you would add the assets at the end of last year plus those at the end of this year and divide by two.

How the Earning Assets to Total Assets Ratio Works

Here's an example: Lance likes to invest his money to generate passive income. While he enjoys working, 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 such as furniture and clothing. During the year, he saves $80,000 and invests it all in additional stocks, bringing the new stock total to $330,000.

Begin by separating out the earning assets from the nonearning assets and adding 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 personal balance sheet, or 60 cents of every dollar he holds, are earning money for him. 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 generating for you.

Limitations of the Earning Assets to Total Assets Ratio

Although this ratio provides an important look at how much of your portfolio is working to earn you income each day, it's important to 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 representing cash in your pocket, decreases the long-term value of the stock.

Those cash payouts are money not reinvested into the company's growth, limiting its long-range earning potential. Companies that keep reinvesting earnings into new growth can grow immensely over time, so keep that in mind as you're choosing your stocks. The right earning assets to total assets ratio for you will depend on your passive income needs vs. your long-term return expectations.

Key Takeaways

  • The earning assets to total assets ratio is a formula that banks, companies, and individual investors can use to evaluate the proportion of their assets that are actively earning money.
  • This helps an investor evaluate how effective their 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.

Article Sources

  1. Fidelity. "Why Dividends Matter." Accessed July 14, 2020.