Although there are multiple formulas, return on assets (ROA) is usually calculated by dividing a company’s net income by the average total assets. Average total assets can be calculated by adding the prior period’s ending total assets to the current period’s ending total assets and dividing the result by two. Return on assets (ROA) is a measure of how efficiently a company uses the assets it owns to generate profits. Managers, analysts and investors use ROA to evaluate a company’s financial health. Because of the balance sheet accounting equation, note that total assets are also the sum of its total liabilities and shareholder equity.
- ROE is calculated by dividing a company’s net profits over a given period by shareholders’ equity—it measures how effectively the company is leveraging the capital it has generated by selling shares of stock.
- The first company earns a return on assets of 10% and the second one earns an ROA of 67%.
- One of management’s most important jobs is to make wise choices in allocating its resources, and it appears Macy’s management, in the reported period, was more adept than its two peers.
It serves as an essential consideration in evaluating the prospects of potential investments. Operational costs can include cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property. Mutual funds give investors exposure to lots of different kinds of investments.
Calculating ROA using net profit margin and asset turnover
Every dollar that Macy’s invested in assets generated 8.3 cents of net income. Macy’s was better at converting its investment into profits, compared with Kohl’s and Dillard’s. One of management’s most important jobs is to make wise choices in allocating its resources, and it appears Macy’s management, in the reported period, was more adept than its two peers. If your ROA is less than the cost of capital, then it means that your company needs to make more money to cover its costs and maintain current operations. In addition, if your ROA is less than the cost of debt (which would be equal to interest payments), then you’re losing money on every dollar in debt owed by your company. In closing, the return on assets (ROA) metric is a practical method for investors to grasp a better understanding of how efficient a company is at converting its asset purchases into net income.
To reiterate from earlier, the higher a company’s ROA, the more operationally efficient management is at generating more profits with fewer investments (and vice versa). Brixx offers comprehensive financial forecasting tools to help you track important metrics like ROA, so you can make data-driven decisions for your business. Start your free trial today and empower your business with the insights you need for long-term success. Return on assets compares the value of a business’s assets with the profits it produces over a set period of time.
However, if you compared the manufacturing company to its closest competitors, and they all had ROAs below 4%, you might find that it’s doing far better than its peers. Conversely, if you looked at the dating app in comparison to similar tech firms, you could discover that most of them have ROAs closer to 20%, meaning it’s actually underperforming more similar companies. For example, an asset-heavy company, such as a manufacturer, may have an ROA of 6% while an asset-light company, such as a dating app, could have an ROA of 15%. If you only compared to two based on ROA, you’d probably decide the app was a better investment.
Video Example of Return on Assets in Financial Analysis
If ROA examines how well a company is managing the assets it owns to generate profits, ROE examines how well the company is managing the money invested by its shareholders to generate profits. A rising ROA tends to indicate a company is increasing its profits with each investment dollar invested in the company’s total assets. A declining ROA may indicate a company might have made poor capital investment decisions and is not generating enough profit to justify the cost of purchasing those assets. A declining ROA could also indicate the company’s profits are shrinking due to declining sales or revenue. Comparing profits to revenue is a useful operational metric, but comparing them to the resources a company used to earn them displays the feasibility of that company’s existence. Return on assets is the simplest of such corporate bang-for-the-buck measures.
A high ROA indicates that a company efficiently uses its assets to produce a profit. A low ROA may suggest that the company must invest more to increase profitability. Your finance team and analysts need to monitor this metric carefully because it can provide valuable insight into how well a company performs financially.
Return on assets is a measure of how well a company turns its owned capital into profit
ROA can also be used to make apples-to-apples comparisons across companies in the same sector or industry. The ROA calculation method that uses only net income and total assets is simpler than the method that uses net profit margin and asset turnover. However, the latter method more accurately conveys a company’s ROA throughout the reporting period, while the simpler method expresses a company’s ROA only at the close of the period. And, using the more complex method enables you to learn more about the company by also determining its net profit margin and asset turnover rate.
The metric offers comprehensive insights into a company’s financial health by assessing its operational efficiency and profitability in relation to its assets. This number tells you what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. It’s a useful number for comparing competing companies in the same industry. Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets. As a result, calculating the average total assets for the period in question is more accurate than the total assets for one period. The return on assets (ROA) metric is calculated using the following formula, wherein a company’s net income is divided by its average total assets.
Return on assets (ROA) vs. Return on equity (ROE)
ROA is shown as a percentage, and the higher the number, the more efficient a company’s management is at managing its balance sheet to generate profits. Therefore, these companies would naturally report a lower return on assets when compared to companies that do not require a lot of assets to operate. Therefore, return on assets should only be used to compare with companies within an industry. Net income/loss is found at the bottom of the income statement and divided into total assets to arrive at ROA. ROA is calculated by dividing a firm’s net income by the average of its total assets.
For instance, the cash balance is increasing, which means the company has more liquidity on hand and fewer cash outflows related to inventory purchases and Capex. To reiterate from earlier, the equation for calculating the return on assets is shown below. Regarding the fixed assets base (i.e. the PP&E), the decline of $16m implies fewer capital expenditures are required. Return on assets is one of the elements used in financial analysis using the Du Pont Identity. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree.
