Definition of Average Total Assets
Average Total Assets can be defined as the average amount of assets recorded on the company’s balance sheet at the end of two financial years: the current year and the preceding year. Average Total Assets represent the mean of the total wealth of the business during two timelines.
This figure is mostly used in comparison to the total sales figure. By comparing both of them, accountants attempt to calculate the number of assets required to support the given amount of sales.
Average Total Assets is supposed to be a resourceful comparison, primarily because it directs towards the efficiency with which assets are being utilized in the company.
For example, an organization with lower average total assets and higher sales is likely to be considered more efficient than an organization with higher total assets and lower sales (or profitability).
Therefore, average total assets are used as a metric that indicates how well the company is performing regarding the profitability that the company has generated over the given year.
Explanation of Average Total Assets
The company’s balance sheet is broadly categorized into three main elements: Assets, Liabilities, and Equity.
Assets are defined as resources with a definitive economic value for the respective individual or corporation. The individual or corporation holds that particular resource to expect it to derive further value in terms of profits for the company in the longer (or, the shorter) run.
On the other hand, Liabilities are obligations that a company incurs as a result of its existence and operations. They are future economic sacrifices that a company makes, resulting from their past actions.
Equity is the amount that the company has a net of assets or liabilities. In other words, this is the actual wealth of the company. After all, the company has settled financial obligations.
These three components formulate the accounting equation:
Assets – Liabilities = Equity
The net of assets and liabilities is also referred to as the Total Assets of the company. This is equivalent to the equity of the company.
Alternatively, Total Assets can also be computed by adding up two different categories of assets, Current Assets as well as Non-Current Assets.
Current Assets are assets that are expected to generate an economic benefit to the organization within a frame of 12 months (or 1 year).
On the other hand, Non-Current Assets are resources that a company owns that are likely to generate economic value to the company for a period of more than 12 months (or 1 year). Therefore, by this logic, Total Assets can be calculated as follows:
Total Assets = Current Assets + Noncurrent Assets
The formula above is simply an amalgamation of both current and noncurrent assets to arrive at the company’s total assets.
How to Calculate Average Total Assets?
Average Total Assets are calculated using the following formula:
(Aggregate or Total Assets at the end of the Current Year + Aggregate or Total Assets at the end of the preceding year) / 2
In certain cases, companies might also choose total assets at the end of the given month of the current year to calculate how average assets changed over different months.
When adopting this approach, companies normally take month-end Total Asset balances in order to calculate average total assets across different periods in context.
When organizations choose to deal with periods, the following formula is used to calculate Average Total Assets:
(Total Assets at the end of Period 1 + Total Assets at the end of Period 2 + …… + Total Assets at the end of Period n) / Number of periods (n)
Both of these approaches are equally valid. They are used depending on what the accountants want to check as a result of these metrics.
Some companies might opt for the periodic trail of average total assets since it gives a deeper insight regarding the trajectory of total assets and subsequent changes in profitability due to changes in average total assets.
Example of Average Total Assets
The concept of Average Total Assets is explained in the following example:
Brighto Inc. has the following balances at the end of the two years, 31st December 2019 and 31st December 2020.
|Particulars||31st December 2019||31st December 2020|
|Cash and Cash Equivalents||12,000||15,000|
In order to calculate Average Total Assets for Brighto Inc., the following formula is used:
Average Total Assets = (Total Assets as at 31st December 2019 and 31st December 2020) / 2
Average Total Assets = (110,000 + 140,000) /2 = $125,000
The amount above implies that the average total assets for the year amounted to $125,000. This amount can subsequently be used for other comparisons that can allow companies to make better and informed decisions over time.
Uses and Importance of Average Total Assets
Individually, there might not be much significance about the number calculated as Average Total Assets. However, this metric is still useful for several other purposes. These purposes are as follows:
- Average Total Assets are coupled with other industry averages in order to determine the comparative wealth status of both the companies. From an investors perspective too, average total assets can be used as a performance metric, compared to other competitors operating in the same industry.
- Average Total Assets is used in order to calculate a number of ratios that include Return on Assets (Total Average Asserts), and Asset Turnover Ratio. These ratios are also important in order to gauge the performance of the company, and subsequently compare it with other players in the market.
- Average Total Assets across a given period of time is used in order to determine the performance of the company over the two years. Therefore, it is used for internal evaluation too. For some cases, internal evaluation is used as a very major decision making tool for the company.
What is classified as a reasonable amount for Average Total Assets?
Average Total Assets, in individuality, hold no significant importance. However, when they are compared with other relevant ratios, they are then meaningful.
In this aspect, it is important to consider that average total assets do not have a ‘reasonable’ amount per se. The amount of assets tends to vary from organization to organization, as well as from industry to industry.
A lot of companies require more fixed assets since they are capital intensive in nature. Therefore, they are likely to have a greater asset base compared to other companies.
This implies that having a higher amount for average total assets is not necessarily a positive indicator for the effective profitability of the company. Although it reflects a higher wealth status of the company, it is not an indicator of the company’s operating efficiency.
Hence, there is no threshold of a ‘reasonable’ amount for the average total asset. It is variable across different industries and is only beneficial if compared to the profitability-related metrics of the company.