Exercise: What Do Financial Statements Measure?

by March 25, 2016

Given that ABC Corp’s assets represent wealth controlled by ABC and net earnings represent wealth created during the year, you could form a ratio of net earnings ÷ total assets, which is one version of a popular ratio: Return on Assets or ROA (warning: different acceptable methods exist to calculate this ratio). ROA would help you assess whether a firm such as ABC can generate a high return (create wealth) from its assets (wealth level). To start generating questions as a reporter, this ratio could be:

  • Compared to ABC’s prior year performances to assess trends
  • Compared to ABC managements’ expectations to assess whether they met their goals
  • Compared to competitors
  • Compared to analyst forecasts to assess whether ABC’s management met analysts’ expectations

As an example, for the years 2014 and 2015, Southwest Airlines generated a return on assets of 5.8% and 10.2% while Delta Airlines generated 1.2% and 8.5%. Over the years, Southwest often generates a higher ROA than competitors: It seems better able to manage its assets (which are primarily airplanes) to generate higher returns (create more wealth with its assets) than many other U.S. airlines.