Retained Earnings to Total Asset
Retained Earning to Total Asset is the ratio measure the accumulated earning over a company’s total asset. It shows the percentage of total asset which funded by the retained earnings. This ratio indicates the management expansion overusing the accumulated profit to reinvest rather than paying dividends or draw. Moreover, it shows management intention to overuse debt or new shares to invest in the company asset.
Younger company may not have good retained earnings to total assets, as they do not yet reach profit potential but rather in a loss position. They are highly likely to rely on the share capital or debt to operating.
Retained Earning is the accumulated profit and loss from the beginning of business until reporting date. Profit during the year will increase the amount of retained earnings, however, the loss will reduce the balance. Moreover, retained earnings can decrease due to dividend payout to the shareholders.
Retained Earnings to Total Asset Formula
|Retained earnings total assets ratio = Retained earnings / Total Assets|
Retained Earnings to Total Asset Example
Base on the balance sheet of ABC company, we have the following information.
|Total Current Asset|
|Total Current Liability|
|Long term debt||200,000|
|Total Liabilities and Equity||770,000|
Retained Earnings to Total Asset = Retained Earning / Total Asset
= 200,000/770,000 = 25.97%
It means that 26% of company asset is supported by the accumulated earning from previous years.
Retained Earnings to Total Asset Ratio Analysis
There is no exact percentage that considers as a good ratio, generally, the higher is the better. However, it changes from one industry to another industry. If we look at a new startup company, they are highly likely to rely on debt or shareholders’ capital. But it doesn’t mean that they are in a bad condition. Some startup companies can be sold for millions dollars even they not yet making any profit.
- If the ratio = 0: It means the company relies 100% on debt and shareholder’s capital, they are not yet making any profit and be able to reinvest.
- If the ratio = 1: It means the company relies 100% on retained earnings to operate and invest. It is almost impossible in real life.
- If the ratio >0 but <1: It means partial assets are funded by retained earnings while the rest are funded by debt or share capital. It depends on the percentage of ratio.
Advantages of Higher Retained Earnings to Total Asset
|Less likely to bankrupt||By relying on the retained earnings to fund business, the company will be less likely to bankrupt if compare to using debt. The debtor can put pressure on the company by demanding payment.|
|Long term source of fund||The loan is long-term debt, but retained earning is even longer source of funds. When a company relies on retained earning, they will be able to use for a long period before payback to shareholders in form of a dividend.|
Retained Earnings to Total Asset ratio should be used with other tools to evaluate the business. Rely only on this ratio will be hard to access the company’s strength and weakness. It very hard to compare the long-established companies with a new start-up. New startups are highly likely to fall behind on this ratio but it does not mean they are in a higher risk position. The companies from different industries will have a huge difference in this percentage.