Looking at the return on assets
Written by: James K. Allred

The late Mike Walsh, who helped turn chronic underachiever Tenneco into a powerhouse, had firm opinions about what he called "lazy assets." He believed that a strong return on assets was one of the best gauges of corporate health. And, in fact, return on assets (ROA), sometimes called the "productivity ratio," is indeed one of the most important measures of a company's efficiency and productivity.

In earlier columns, we discussed the many places that a well-designed material flow system can reduce asset expenses like building and inventory while boosting productivity. By calculating the predicted ROA of a totally new material han-dling system versus the expansion of your current system, you can clearly show the benefit to your company.

Let's take the mythical ABC Corp. as an example. Its target is to expand sales by 30% while increasing both its ROA and profitability. The alternatives are to beef up the current system to meet the new objectives or to invest in a new material flow system.Which option will best meet its goals?

In the example presented here, (see chart) we can see that the expected sales volume of $50 million requires $10 mil-lion in buildings, $10 million in equipment, and $10 million in inventory. To reach the new sales target of $65 million, ABC Corp. will need to increase its average assets by the same percentage. That means building, equipment, and inventory assets all must go up by 30% to $13 million each.

Of course, net profits also rise, but the rate of return on ABC Corp.'s assets remains the same as before. In theory, if the company is satisfied with this ROA, doing more of the same (in terms of systems) is a viable option.

But let's look at what happens when ABC invests in a well-designed material handling and control system. Because the new system cuts cycle time and speeds order fulfillment, sales can actually be increased to $70 million. What's more, although the system cost of $2.5 million increases equipment assets, the new sys-tem fits easily into the current building -- actually saving $3 million in building assets.

Best of all, the new system not only increases the profit percentage, but allows ABC Corp. to cut average inventory down to $7 million while doubling the number of inventory turns.The result? The new materials handling system yields an ROA of 36.9%, some 85% better than the old system.Which investment would you make?

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