What Is Return on Assets (ROA)?
Return on assets (ROA) is a financial ratio that can help you analyze the profitability of a company. ROA measures the amount of profit a company generates as a percentage relative to its total assets.
Return on assets is a comparison metric that can be used to examine past performance of a company or view similar companies side by side.
How to Calculate Return on Assets
A company’s return on assets (ROA) is calculated by looking at the net income and assets found on two financial statements. Net income can be found on the company’s income statement while assets can be found on the company’s balance sheet.
The income statement and the balance sheet should be from a set period of time (such as annually or quarterly) to calculate ROA.
Return on Assets Formula
To calculate ROI, use the general formula provided below:
*Note that professional accountants will calculate ROA using a more complex formula known as the DuPont disaggregation.
Return on Assets Example
Say that a company has $10,000 in total assets and generates $2,000 in net income. It’s ROA would be $2,000 / $10,000 = 0.2 or 20%.
What Does the Return on Assets Ratio Mean?
ROA measures the return on investment for the company. Investors, analysts, and managers will want to know if the company can provide a good return on assets. This ratio is the first step for any company or investors to review performance benchmarked against its peers.
What Is a Good Return on Assets Ratio?
A good ROA indicates that a business is doing well in managing its assets.
To determine a solid ROA, you’ll want to review the average ROA in a company’s specific industry. If the average ROA for the manufacturing industry is 7% – and a company’s ROA you’re examining is 8.2% – they are doing well with their asset management. Generally, a company's ROA should be within the same range as competitors in its peer group.
Yet, if a company has a much higher ROA than the average of its peer group, let’s say 12% compared to the 7% average, this could mean one of two things:
They are managing those assets better to produce more income, or
The company owns outright fewer assets and instead leases or borrows additional assets. Only owned assets are reflected in ROA. In general, this means the lower the total asset value, the higher the ROA.
Earnings capability and management are important factors, but so is the method by which the company finances its assets.
To increase their ROA, companies can look at the denominator (assets) or numerator (net income) in the equation. Ideally, a company can create the greatest amount of value from the least amount of assets.
How Debt Impacts ROA
A company taking on debt will likely use those funds to acquire assets. When the total value of assets increases, there should be a corresponding increase in net income. In this way, ROA can remain stable or increase. ROA is an important calculation because it accounts for debt a company may have taken on to grow.
A company can increase their ROA by another method that keeps debt off the balance sheet: leasing assets. Leased assets are not owned. Because of this, they are not reflected on the balance sheet and not counted towards total assets. By choosing to lease assets, a company can actually increase its ROA with net income.
When You Should and Shouldn’t Use ROA
ROA is most useful in two scenarios:
To examine a company’s past profitability and look for growth/downturn
To compare companies within a similar industry.
ROA Shouldn’t Be Used Across Different Industries
For example, a marketing agency’s ROA can’t be compared to an industrial manufacturing company’s ROA. That’s because they have different asset bases. A manufacturing company is going to own more assets (e.g. warehouses, shipping containers) to create their products and parts than a marketing agency.
ROA is only one calculation for analyzing a company. Investors will use multiple metrics such as Return on Equity (ROE) before deciding to buy shares.
What Is the Difference Between ROA and Return on Equity (ROE)?
Return on Equity (ROE) is measured by dividing net income by equity. Equity is the value of total assets less total liabilities and represents the value held by shareholders. Thus, ROE is also dependent on total assets. ROE measures the return made by a company in relation to the value of the company held by shareholders.
ROE and ROA are just a few of many different parameters an investor can use to compare the performance of a company in the current quarter to past quarters and past years. ROE and ROA can also give an idea as to how a company is performing in relation to its peers.
Why Does ROA Matter?
The profit percentage of assets varies by industry, but in general, the higher the ROA, the better. For this reason, it is often more effective to compare a company's ROA to that of other companies in the same industry or against its own ROA figures from previous periods.
Falling ROA is almost always problematic and means that assets aren’t providing value. Investors, analysts, and managers should use ROA as one metric to view company success.
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