Return on Assets: What It Is and How To Calculate It
Return on assets is a key metric that indicates whether a company is making effective use of its assets to generate profit. ROA is typically used by analysts and company managers, but it can also be a great tool for investors. It’s often linked with return on equity. ROA and ROE can be used together to get a clearer picture of how a business is performing.
What Is Return on Assets?
Return on assets or ROA is a term used to describe the financial ratio that indicates whether or not a company is profitable when compared to its total assets. ROA is typically used to determine if a company is making efficient use of its assets to generate a profit.
How To Calculate ROA
ROA is calculated with a simple formula:
ROA = Net Income / Total Assets
As an example, let’s imagine that Company A has spent $10,000 on its business while Company B has spent $25,000. Company A earns $1,800 in a given period, whereas Company B earns $3,600.
Company A’s ROA would be $1,800 / $10,000 = 18%
Company B’s ROA would be $3,600 / $25,000 = 14%
This means that Company A would be the less valuable business, but it would have a higher ROA because it makes more efficient use of its assets. In comparison, Company B would be the more valuable business, but its ROA is lower, which means it’s not making the most optimal use of its assets.
This is a basic ROA formula that can be expanded based on the needs of the company or the industry that it’s in. For example, the net income calculation could involve many other figures and metrics to paint a more accurate picture of a company’s ROA.
It’s also possible to get a more accurate ROA number by substituting the total asset value with an average asset value. This takes into account the changes a company might see in its asset value over time. In most cases, this means calculating the average value of assets of a company owned in a given year instead of the given value at the end of the year. This helps to give a more accurate ROA value.
Why Use This Metric
The most important consideration when running a business is efficiency. Every company requires some upkeep in the form of assets, resources, or other costs. To be successful, a business needs to generate more money than it’s spending. Efficiency is the key here, but there are many ways to calculate it.
So, to simplify things, metrics such as ROA are used to get a brief overview of how well a business is performing. It’s often used to compare multiple companies in the same industry. For example, if an investor wants to compare two competitors, it’s possible to use a ROA value to get a rough idea of how well each company performs. Although their overall value might be roughly the same, it can show that one company is better at making efficient use of its assets than the other.
ROA isn’t a highly specific metric, but it’s also not designed to be one. It’s a comparative measure used to glance at companies to determine their performance and not a metric that helps to diagnose problems within a business such as its workflow, productivity issues, and department-specific grievances.
How To Use Return on Assets
There are several practical ways to make use of ROA numbers.
In most cases, it’s used as a simple metric to judge a single company’s performance. When your ROA rises over time, it indicates that your company is doing a good job of utilizing its assets correctly. You’re essentially squeezing as much value as possible from all of your assets. On the contrary, a declining ROA could indicate that you’re making bad investments, that you’re not using your assets correctly, or that your staff isn’t being trained well enough to make use of those assets.
While ROA can be a helpful indication of a business’s general profitability and current health, it’s a very general surface-level examination. For example, if a ROA calculation reveals that your business is not making good use of its assets, then you need to perform further investigations using other metrics to determine why.
But if you already have these metrics available, then it’s much more helpful to look at them first because it’ll show your company’s situation in greater detail. As such, for day-to-day operation and optimization, ROA isn’t very helpful.
Where ROA does shine is in the long-term analysis of a business and for compiling reports for investors. It can also be used when a company is going through restructuring or if new senior staff members join to see if they are effective in their intended role. In short, a company’s ROA is a great indication of how long-term changes affect its performance.
What Are the Limitations of ROA?
While ROA can be a good indication of how well a business is utilizing its assets, it’s hard to use it as a metric to compare two companies in different industries. Some industries are required to have expensive assets that don’t generate the same amount of profit. In comparison, other industries have much lower base asset costs, which means their ROA can be a lot higher.
In addition, while ROA is helpful to measure a company’s asset utilization, it doesn’t mean that the company is less successful or less profitable in general. Due to these limitations, there are few practical uses for ROA.
Some types of businesses, such as banks, can make much better use of a ROA formula because their balance sheets are a good representation of the value of their assets and liabilities.
On the contrary, a tech company with a lot of assets and employees will find it difficult to measure its total asset worth, making it hard to calculate an accurate return on assets ratio.
ROA vs. ROE
Return on equity is another financial ratio similar to ROA. Together, they can be used to effectively measure the performance of a company.
ROE is intended for measuring how effectively a company is leveraging capital generated from selling shares of stock. It’s calculated by dividing a company’s net profits in a given period by the shareholders’ equity. Investors typically use ROE to see how effective their investments are. Together, ROA and ROE can be used to get a better understanding of how well a company is performing and how well it’s utilizing all of the assets and resources it has available.
Calculating return on assets is a great way to get a rough idea of how well a company is utilizing its assets. However, it’s important to remember that it’s best used when assessing a company’s performance over a long period of time instead of using it as a metric to identify and solve issues within a company.
How do you calculate return on assets?
ROA is calculated with the following simple formula: ROA = Net Income / Total Assets
What is a good return on assets?
This is a difficult question to answer because every industry has different ROA averages. In general, a positive ROA is always a good thing because it means that your assets are helping you generate profit. In most cases, a value between 5% and 20% would be considered average.
However, it’s always best to compare average ROA ratios with other companies in the same industry. This helps you get a better idea of how you’re performing in relation to your competitors.
What does return on assets mean?
Return on assets refers to the financial ratio that indicates whether a company is making good use of its assets. It’s typically used to see if a company is profitable in relation to the cost of its assets.
What is good ROE and ROA?
Good ROE and ROA mean that a company is making effective use of its assets. For ROE, it means that the company is making use of the capital it’s generating through selling shares of stock. For ROA, it means that a company is making effective use of its assets to generate profit.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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