Key Takeaways
- Return on Asset (ROA) is expressed as a percentage and it indicates how profitable the company is relative to the total assets that it owns.
- ROA is a ratio between the company’s net income and its total assets
- Greater the value of ROA, better is the management presumed to be at efficiently using their assets
What is Return on Assets (ROA)?
Return on Asset (ROA) is expressed as a percentage and it indicates how profitable the company is relative to the total assets that it owns. It provides investor and analysts with a picture of how efficiently the company’s management is at handling its assets to generate earnings.
How to Calculate ROA
Comparing a company’s profits and income to resources that it used to generate those profits is a useful metric in determining the feasibility of the company’s existence. ROA is calculated using the following formula:
Return on Assets (ROA) = Net Income / Total Assets
Where a company’s net income is reported in its income statement while its total assets are reported in the balance sheet.
To better understand, If a company’s ROA is 10%, this means the company earns 10 dollars for every dollar it has in assets.
Understanding ROA
Greater the value of ROA, better is the management presumed to be. However, it is important to understand that ROA is best applicable if it is used in comparison with companies with the same level of capitalization. Achieving a high ROA is difficult if the business is highly capital intensive.
In contrast to return on equity (ROE), ROA measurement is inclusive of all of the company’s assets, including those which arise from liabilities to creditors along with capital paid in by the investors. Total assets are used instead of just net assets.
A company’s ROA can indicate both, effective use of the assets or if they’re being underutilized, resulting in undercapitalization. Both investors and business owners can benefit from knowing a company’s ROA because by determining the company’s efficiency in generating profits from assets. They can compare this information to the historical data of the company. That way, they can come up with trends and patterns that can further help them determine whether or not any potential issues may arise in the future.
