What is the 'Cash Return On Assets Ratio'

The cash return on assets ratio is used to compare a business' performance among other industry members. It is an efficiency ratio that rates actual cash flows to company assets without being affected by income recognition or income measurements. The ratio can be used internally by the company's analysts or by potential and current investors.

BREAKING DOWN 'Cash Return On Assets Ratio'

Fundamental analysts believe a stock can be undervalued or overvalued. That is, fundamental analysts believe in-depth analysis can help increase portfolio returns. To do this analysis, fundamental analysts use a variety of tools including ratios. Ratios help analysts compare and contrast data points such as return on assets (ROA) and cash ROA. When these two ratios diverge, it is a sign that cash flow and net income are not aligned, which is a point of concern for analysts.

ROA vs. Cash ROA

Return on assets is calculated by dividing net income by average total assets. The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings. A high ratio means the company earns more net income from $1 of assets than the average company, which is a sign of efficiency. A low ratio means a company makes less net income per $1 of assets, which is a sign of inefficiency. The issue is net income is not always aligned with cash flow. As a solution, analysts use cash ROA, which divides cash flows from operations (CFO) by total assets. Cash flow from operations is specifically designed to reconcile the difference between net income and cash flow. In this way, it is a more accurate number to use in the calculation of ROA than net income.

As an example, if company A has a net income of $10 million and total assets of $50 million, ROA is 20%. Company A also has high sales growth due to a new financing program that gives all customers 100% financing. As a result, net income is high, but the increase in net income is due to an increase in credit sales. These credit sales increased sales and net income, but the company has received no cash for the sales. Cash flows from operations, a line item that can be found on the cash flow statement, shows the company has $5 million in credit sales. Cash flows from operations deducts this $5 million in credit sales from net income. As a result, cash ROA is calculated by dividing $5 million by $50 million, which is 10%. In actuality, assets generated a lower amount of "real" cash earnings than originally thought.

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