A Guide To Return on Assets (ROA)

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How to calculate ROA

Follow these steps to calculate a companys return on assets:

1. Determine the net income

Apart from the revenue the company has generated through sales, the net income should also include additional income, such as interest earned from investments. You can find your companys net income and loss at the bottom of the income statement.

2. Determine the average total assets

You can find a summary of your companys total assets on your balance sheet. It will show all of your businesss assets, including cash, accounts receivable, tools, inventory, vehicles and buildings. Non-tangible things like intellectual property are also part of your total assets. To calculate the average total assets over a period of time, add the value of the assets at the beginning of the accounting period to the value at the end, and then divide the result by two.

3. Divide the net income by the average total assets

Once you have determined the net income and the average total assets, you can apply the following formula:

Return on assets = net income / total assets

The result will be the ROA ratio of a company over a specific period of time. For example, lets say you want to calculate the ROA of a company that has a net income of $200,000 at the end of the year.

To calculate the average total assets, you need to add the total assets of two consecutive years. In year one, the company had $3 million in assets, and it had $4 million in year two, which amounts to $7 million. $7 million divided by two gives you an average total assets amount of $3.5 million. To calculate the ROA ratio, you divide $200,000 by $3.5 million, which amounts to 0.057. Lastly, multiply this number by 100, which will give you a percentage of 5.7%.

What is ROA?

Return on assets (ROA) is an indicator that shows how successful a company is in generating revenue from its assets. Since the main purpose of a companys assets is to generate income, this profitability ratio is an effective tool that investors or buyers can use to gauge how well a company is performing. It can give you an idea of how well a company can convert the money it spends into net income.

The ROA ratio is indicated as a percentage. The higher the percentage, the more effective a company is at using its resources. A higher number indicates that the company earns more money using fewer assets.

The benefits of the ROA metric

Apart from judging how efficiently a business uses its assets to generate income, investors and company executives can also use ROA ratios to compare different companies within the same industry. If a company displays a higher ROA percentage than others, it may serve as an indication that its outperforming its competitors.

You can also use ROA to determine how asset-intensive a company is. A low ROA percentage of below 5% is an indication of an asset-intensive company. This doesnt necessarily mean that a company is underperforming, though. Certain companies, such as airlines, are naturally more asset-intensive than, for instance, software companies, which are asset-light businesses.

The limitations of the ROA metric

The biggest limitation of applying the ROA ratio when comparing companies is that you cannot use it across industries. This is because some industries and companies require expensive equipment, properties and plants, such as airlines and manufacturers, while others spend far less on assets to generate income. A service company, for instance, has a minimal investment in assets, which results in a very high ROA.

Another reason why its sometimes challenging to compare the performance of companies based on their ROA ratios is that some companies use a different ROA formula. This involves using their operating income and not their net income as the numerator.

ROA vs. ROE

ROA used to be the preferred way to compare banks to each other and also for banks to monitor their own performance. Although some banks, especially smaller banks, still use ROA, the indicator most banks use today is the return on investment (ROE) metric.

ROA and ROE are both ratios that indicate how profitable a company is. Whereas ROA helps investors understand how well management is using its resources to generate income, ROE demonstrates a companys ability to turn equity investments into profits.

Both the ROA and ROE formulas use net income as a numerator. However, while the ROA formula uses assets as the denominator, the ROE formula uses shareholder equity. Shareholder equity equals assets minus liabilities. Its this inclusion of liabilities that differentiates ROE from ROA. If a company has no debt, its shareholder equity and total assets would be equal, and so would its ROE and ROA ratios.

A high ROE ratio is an indication that a company is likely capable of generating cash internally and probably doesnt need to rely too much on debt financing. ROE has recently gained popularity as a profitability metric, especially because you can apply ROE to any line of business since its not asset-dependent.

This flexibility makes the ROE metric a useful tool for comparing companies with different asset structures. However, investors and company executives often use both ROA and ROE values, along with other profitability measures such as gross margin or net margin, to determine how well a company is performing.

FAQ

What ROA means?

Return on assets (ROA), also known as return on total assets, is a measure of how much profit a business is generating from its capital.

What is a good ROA?

An ROA of 5% or better is typically considered good, while 20% or better is considered great. In general, the higher the ROA, the more efficient the company is at generating profits. However, any one company’s ROA must be considered in the context of its competitors in the same industry and sector.

What does ROE and ROA stand for?

Return on Equity (ROE) is generally net income divided by equity, while Return on Assets (ROA) is net income divided by average assets. There you have it. The calculations are pretty easy. But, what do they mean? ROA tends to tell us how effectively an organization is taking earnings advantage of its base of assets.

How do you calculate ROA?

How to calculate ROA. There are two separate methods you can use to calculate return on assets. The first method is to divide the company’s net income by its total average assets. The second method is to multiply the company’s net profit margin by its asset turnover rate.

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