Definition:
Average Total Assets can be defined as the average amount of assets that are recorded on the Balance Sheet of the company, at the end of two given financial years.
This can either include both, the current year, as well as the preceding year. Alternatively, it can also constitute two different time periods across which a company wishes to calculate the Average Total Assets.
Average Total Assets are an indication of the total wealth that is possessed by the company, and how it changes across two different timelines. Average Total Assets is used in conjunction with other metrics, like Total Sales, to calculate how these projections change with the course of time.
Average Total Assets directly indicate the financial standing of the company. It is preferred to be used in place of Total Assets because it helps companies to determine a more reasonable and accurate analysis regarding the actual financial standing of the company.
Explanation of Average Total Assets
The basic accounting equation has three components, namely Total Assets, Total Liabilities, and Total Equity. Using these parameters, the basic accounting equation is as follows:
Total Assets – Total Liabilities = Equity of the company
By definition, Assets are defined as the possessions owned by the company, which are expected to generate positive returns and utility for the company.
Therefore, Total Assets include both, Current Assets, as well as Non-Current Assets that are owned by the company. Hence, Total Assets can simply be calculated by adding both, Current Assets, as well as Non-Current Assets that a company owns:
Total Assets = Non-Current Assets + Current Assets
It is important to include both these parameters since it greatly impacts the overall asset outlay of the given company. Furthermore, it is also important to realize the fact that both these categories, regardless of their liquidity position are, in fact, owned and possessed by the company.
In case of liquidation, these resources can be used to generate cash for the organization.
Average Total Assets is simply the mean amount of assets in a company, over a period of time. In this aspect, it is also important to inculcate the importance of calculating and using Average Total Assets and not just Total Assets.
During year-end, the organization might have different transactions that can over-inflate assets. These one-off transactions might not correctly depict the actual financial position and standing of the company.
Using Average Total Assets somewhat reduces the likelihood of this error occurring, and hence, this estimate is more useful from the perspective of the company.
Furthermore, it is also important to note the fact that Average Total Assets is used as an indicator of performance, from one timeline to another. Using standalone figures might not give a similar and accurate depiction of these assets.
Formula for calculating Average Total Assets
Average Total Assets is calculated using the following formula:
Average Total Asset = (Assets at the beginning of Period 1 + Assets at the beginning of Period 2 + Assets at the beginning of Period 3) / (Number of periods, n)
The formula above represents the calculation required for Average Total Assets. It is basically the mean asset value that the organization possessed over the period of years for which the calculation is being conducted.
It can be seen that Average Total Assets can be calculated over different periods. It does not necessarily have to be across two-year-ends, but can also be calculated using 3-year or 5-year windows.
Example of Average Total Assets
The concept of Average Total Assets, along with its explanation is illustrated in the following example:
Kegs Co. has the following balances at the end of three years ended 31st December 2018, 31st December 2019, and 31st December 2020. The list of balances are as follows:
| Particulars | 31st December 2018 | 31st December 2019 | 31st December 2019 |
| Current Assets | |||
| Cash and Cash Equivalents | 10,000 | 25,000 | 30,000 |
| Accounts Receivables | 12,000 | 15,000 | 20,000 |
| Inventory | 8,000 | 10,000 | 20,000 |
| 30,000 | 50,000 | 70,000 | |
| Non-current Assets | |||
| Net Equipment | 40,000 | 50,000 | 90,000 |
| Property | 10,000 | 20,000 | 10,000 |
| 50,000 | 70,000 | 100,000 | |
| Total Assets | 80,000 | 120,000 | 170,000 |
In the same manner, the Total Sales amount for Kegs Co. over the three years are as follows:
| Particulars | 31st December 2018 | 31st December 2019 | 31st December 2019 |
| Sales | $1,000,000 | $1,200,000 | $1,300,000 |
In order to calculate Average Total Assets calculated above, the following methodology will be used:
Average Total Assets = (Assets at the end of 2018 + Assets at the end of 2019 + Assets at the end of 2020) / 3
Average Total Assets = (80,000 + 120,000 + 170,000) / 3
Average Total Assets (2018, 2019, and 2020) = $123,333.
Similarly, if the Average Total Assets between 2018 and 2019 were to be calculated, the following calculations will be required:
Average Total Assets (2018, 2019) = (Assets at the end of 2018 + Assets at the end of 2019) / 2
Average Total Assets (2018, 2019) = (80,000 + 120,000) / 2 = 100,000
Similarly, if the Average Total Assets between 2019 and 2020 were to be calculated, the following calculations will be required:
Average Total Assets (2018, 2019) = (Assets at the end of 2018 + Assets at the end of 2019) / 2
Average Total Assets (2018, 2019) = (120,000 + 170,000) / 2 = 145,000
Therefore, it can be seen that Average Total Assets can be calculated across different timelines, and hence, this is used as a matter of interpretation in this aspect.
Interpretation of Average Total Assets
Average Total Assets are used as points of interpretation by companies, on a number of different grounds. Factually, it is used to depict a trajectory in the Total Asset Balance over the years.
From the perspective of investors, an increase in Average Total Assets over the course of time is a good indication of the financial well-being of the company.
In the example mentioned above, it can be seen that Kegs Co. has an increasing number of assets over the course of time, as presented earlier. From an investor’s perspective, this is a good sign, since increasing Average Total Assets are a testament to a good performance by the company.
Average Total Assets are also used by companies alongside metrics like Total Sales, in order to determine the efficiency with which resources are fully used.
Depending on the information presented above, it can be seen that Sales to Total Assets can be calculated as follows:
Total Assets to Sales (2018) = $80,000 / $1,000,000 = 8%
Total Assets to Sales (2019) = $120,000 / $1,200,000 = 10%
Total Assets to Sales (2020) = $170,000 / $1,300,000 = 13.1%
As mentioned earlier, it can be seen that Total Assets to Sales as also increased for Kegs Co. over the course of years. This implies that the efficiency of the company has also increased over the course of time.
This can also be compared with other industry averages in order to determine the existing efficiency of the company. Naturally, companies that have a higher Total Assets to Sales ratio will be preferred by the investors since they are more efficient in terms of generating revenue with respect to the total assets that they have on hand.
Similarly, Average Total Assets can also be used alongside the profitability of the company, in terms of ensuring that higher profitability is attained, and organizations are able to get the maximum benefit out of the existing state of affairs.
The post How to Calculate Average Total Assets? (Definition, Formula, Example, and More) appeared first on CFAJournal.
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