Yield on Earning Assets
The yield on earning assets is a common measure of financial ability to pay, designed to compare a financial entity's interest income to its earning assets. The yield on earning assets demonstrates the effectiveness of the assets, and an important criterion for this assessment is the income that these assets bring.
What is Yield on Earning Assets
The solvency ratio is a clear and unambiguous criterion that determines the ability of financial entities to meet their obligations and stay afloat. The yield on earning assets is a method that allows regulatory authorities to identify the amount of money a company earns on its assets. The higher the yield on earning assets, the better, as this indicates the company's ability to meet its short-term obligations, and the risks of default and insolvency are minimized.
Lending and financial institutions that issue loans and provide options for investment offer yields and constantly seek a balance between the various kinds of investment products, the interest rates charged and the term of these investments. Taking these factors into account, it is possible to measure the amount of interest income that will be received from a debt investment for a specified period of time. After that, the received interest income is subject to comparison to the value of earning assets.
It should be mentioned that there is a relationship between the loan to asset ratio of a company and its yield on returning assets, namely, with the growth of one indicator, also grows another one. This is mostly because with an increase in the number of loans issued, the interest income received also increases.
High and low Yield on Earning Assets
When an enterprise gain a significant income from loans and investments made, it is a criterion for high yield on earning assets, which in many cases is the result of a competent policy and actions involving securing loans at appropriate prices, proper investment management and creating business opportunities for companies in order to take a significant market share.
On the contrary, a low yield on earning assets indicates a high risk of insolvency of a financial entity, and therefore it is in the sphere of interests of regulatory authorities. A low ratio occurs if a financial institution makes loans that perform poorly due to the fact that interests on these issued loans reach the value of the earning assets.
Regulatory authorities may regard this indicator as a possible inability of a company to cover losses in the future, and, accordingly, they may rate the odds of insolvency of such a company as very high.
As an indicator of efficiency, the yield on earning assets can be helpful to compare different companies relative to their asset bases. Thus, enterprises that are able to generate significant yield with a not a very large asset base are the most efficient.
How to increase a low Yield on Earning Assets
In order to increase a low yield on earning assets, it is most often necessary to restructure and make qualitative changes to the company's policy, involving more competent risk management, well-balanced investment strategy and a thorough analysis of operations that help choose which loans should be provided to which markets.
When preparing financial statements, the yield on earning assets can be adjusted taking into account various methods based on the company's strategy or business features. So certain off-balance sheet items can have a distorting effect on the reported yield on assets, for example.
In order to maintain competitiveness and the possibility of business development, financial entities may charge lower interest rates, which gradually leads to a reduction in the income received. So in this regard, in some cases, it may be necessary to revise the pricing policy of the company.
