Return On Assets (ROA)
Return on assets (ROA) is a measurement of how profitable a business is compared to its assets. It is a ratio that helps us to understand what the company is doing with the assets they have available to them. Are they managing their assets wisely?
Not all businesses have—or need—a wide range of assets. Some companies can run mostly through capital and service-focused experiences. In contrast, some businesses require a higher amount of assets in order to function or survive on the market. It may seem like understanding assets isn’t as important as other metrics, like profits.
However, if a company were to go under, assets remaining can still be liquidated for a cash value. This can be an attractive level of security for investors. Because of this, an ROA shoots straight for the heart of a company’s stability. Using ROA, you can determine what a company is built on and what they are doing with it.
Return On Assets Formula
Since the ROA is a ratio, it can be expressed as a percentage for easy comparisons by multiplying the result by 100. For this formula, you will need to know the company’s net income. Net income is calculated by subtracting expenses from your income.
Also, unlike some other formulas, the ROA uses total assets and not net assets. Net assets include a company’s liabilities subtracted from its total assets. But a business’s total assets will include both their cash and other items that have a cash value. These could include their accounts receivables, real estate, machinery, goods in their inventory, etc. So, this formula takes on a company’s assets and considers its debts as well. All of this information can typically be found on a balance sheet.
This version of the ROA formula can help you to evaluate the return on all your assets currently. However, if you are looking backwards to evaluate different periods of time, there are a couple of other options to help make your calculation more accurate.
- First, you could divide your net income by the average assets for your time period. This would give you an estimate of the ratio throughout that period. If your assets often change over time, looking at the average could be more beneficial for you.
- Second, you could divide your net income by the ending asset amount in that period. This might give you a more real-time estimation of your assets for that period.
Thanks to its flexibility, you can choose the method that will help you to see the most accurate ratio depending on the context. However, this flexibility can also be potentially dangerous. By using different numbers you might be misrepresenting your actual ROA. It’s important to remember to be transparent about what numbers you are using and why. Additionally, you should be consistently using the same source for your numbers (total, average, ending totals) as you compare periods or companies.
Typically, an ROA of below 5% shows that the company is not experiencing growth. Above that number, the company is likely doing a good job of utilizing their assets properly to create growth. Companies with higher ROA are usually more profitable.
Return On Assets Example
A book publishing company wants to see how they are doing with handling their assets compared to other companies in their industry. They decide to evaluate this based on their ROA for the last year. Their total assets for last year were $111,043. Their net income for that time period was $3,652. What is their return on asset ratio?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Net Income: 3652
- Total Assets: 111043
We can apply the values to our variables and calculate the return on assets:
In this case, the book publishing company would have a return on asset ratio of 0.03288 or 3.29%.
Even without looking at the rest of the market, we can see that the company is probably underperforming. This is because their ROA is less than 5%. They may want to rethink some of their plans for growth or look at how they could better use their assets.
Return On Assets Analysis
The return on assets equation is a ratio that can shine a light on how successful a company’s management is at development and growth. Because this formula looks at the total assets and not net assets, this isn’t a very popular formula for investors. They are more interested in profits, especially since liabilities and assets often balance each other out.
As a result, the ROA is usually used more by the companies themselves. It gives them a better understanding of how well they are growing. They can also get an idea of how often they are putting their assets to use. Industries who are more dependent on their assets, like production, energy, or fashion, will be more inclined to rely on this metric as a key indicator. Service-based industries more focused on capital, like marketing agencies, will have a generally lower ROA.
Additionally, companies can use the ROA formula to compare their rate with competitors. Because the rates will change from industry to industry, you should only be comparing two companies within the same industry with similar assets.
Return On Assets Conclusion
- The return on assets ratio is a company’s profitability in relation to its assets
- The return on assets formula requires two variables: Net Income and Total Assets.
- The results of the return on assets ratio is usually expressed as a percentage.
- Depending on the context, you can divide your net income by total assets, average assets, or ending period assets.
- While the ROA rates will vary by industry, a rate of 5% or above is considered positive.
Return On Assets Calculator
You can use the return on assets calculator below to quickly calculate a company’s profitability in relation to its assets by entering the required numbers.
1. What is return on assets?
ROA is a calculation used to assess a company's profitability in relation to its assets. It is a ratio that helps us to understand what the company is doing with the assets they have available to them.
2. How do you calculate return on assets?
The calculation for return on assets is net income divided by total assets. This will give you your company's ROA percentage. The formula is: Return on Assets = Net Income/ Total Assets
3. What is the good return on assets?
A good return on assets is anything above 5%. This generally indicates that the company is making good use of its assets and is profitable in doing so. Anything above 20% is considered excellent. However, ROAs should always be compare to other companies in the same industry to ensure that the ratios are accurate and relevant.
4. What does a low return on assets mean?
A low return on assets could mean that the company is not making good use of its assets. It may also indicate that the company is not profitable. This could be a sign that the company is in trouble and needs to make changes.
5. How do you improve return on assets?
There are a few things that a company can do to improve their return on assets. They can focus on becoming more efficient with their assets, make sure they are using all their assets, or increase their net income. Increasing profits is the most common way to see an improvement in ROA.