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What Is Return On Assets

ROA is a measure of how profitable a company is relative to its total assets. It is calculated by dividing net income by total assets to indicate how efficiently a company is using its assets to generate earnings. ROA can vary substantially between industries so it is best to compare a company's ROA over time or to similar companies. A higher ROA means the company is more effectively converting assets into net income. While ROA accounts for debt, ROE only measures return on equity and will be higher for more leveraged companies. ROA is limited in that it cannot be accurately compared across industries that have different asset bases.

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70 views2 pages

What Is Return On Assets

ROA is a measure of how profitable a company is relative to its total assets. It is calculated by dividing net income by total assets to indicate how efficiently a company is using its assets to generate earnings. ROA can vary substantially between industries so it is best to compare a company's ROA over time or to similar companies. A higher ROA means the company is more effectively converting assets into net income. While ROA accounts for debt, ROE only measures return on equity and will be higher for more leveraged companies. ROA is limited in that it cannot be accurately compared across industries that have different asset bases.

Uploaded by

Darlene Sarcino
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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What Is Return on Assets—ROA?

Return on assets (ROA) is an indicator of how profitable a company is relative to


its total assets. ROA gives a manager, investor, or analyst an idea as to how
efficient a company's management is at using its assets to generate earnings.
Return on assets is displayed as a percentage.

The Basics of Return on Assets—ROA


Businesses (at least the ones that survive) are ultimately about efficiency:
squeezing the most out of limited resources. Comparing profits to revenue is a
useful operational metric, but comparing them to the resources a company used
to earn them cuts to the very feasibility of that company's’ existence. Return on
assets (ROA) is the simplest of such corporate bang-for-the-buck measures.

ROA is calculated by dividing a company’s net income by total assets. As a


formula, it would be expressed as:

Return on Assets=Total Assets/Net Income

Higher ROA indicates more asset efficiency.

For example, pretend Spartan Sam and Fancy Fran both start hot dog stands.
Sam spends $1,500 on a bare-bones metal cart, while Fran spends $15,000 on a
zombie apocalypse-themed unit, complete with costume. Let's assume that those
were the only assets each deployed. If over some given time period Sam had
earned $150 and Fran had earned $1,200, Fran would have the more valuable
business but Sam would have the more efficient one. Using the above formula,
we see Sam’s simplified ROA is $150/$1,500 = 10%, while Fran’s simplified ROA
is $1,200/$15,000 = 8%.

The Significance of Return on Assets—ROA


Return on assets (ROA), in basic terms, tells you what earnings were generated
from invested capital (assets). ROA for public companies can vary substantially
and will be highly dependent on the industry. This is why when using ROA as a
comparative measure, it is best to compare it against a company's previous ROA
numbers or against a similar company's ROA.

The ROA figure gives investors an idea of how effective the company is in
converting the money it invests into net income. The higher the ROA number, the
better, because the company is earning more money on less investment.
Remember total assets is also the sum of its total liabilities and shareholder's
equity. Both of these types of financing are used to fund the operations of the
company. Since a company's assets are either funded by debt or equity, some
analysts and investors disregard the cost of acquiring the asset by adding
back interest expense in the formula for ROA.

In other words, the impact of taking more debt is negated by adding back the
cost of borrowing to the net income and using the average assets in a given
period as the denominator. Interest expense is added because the net income
amount on the income statement excludes interest expense.

Return on Assets—ROA vs Return on Equity—ROE


Both ROA and return on equity (ROE) are measures of how a company utilizes
its resources. Essentially, ROE only measures the return on a company’s equity,
leaving out the liabilities. Thus, ROA accounts for a company’s debt and ROE
does not. The more leverage and debt a company takes on, the higher ROE will
be relative to ROA.

Limitations of Return on Assets—ROA


The biggest issue with return on assets (ROA) is that it can't be used across
industries. That’s because companies in one industry—such as the technology
industry—and another industry like oil drillers will have different asset bases.

Some analysts also feel that the basic ROA formula is limited in its applications,
being most suitable for banks. Bank balance sheets better represent the real
value of their assets and liabilities because they’re carried at market value
(via mark-to-market accounting), or at least an estimate of market value, versus
historical cost. Both interest expense and interest income are already factored in.

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