What is Return on Assets?

Return on Assets Formula:

Return on assets (ROA) ratio, which is calculated as follows:

Return on Assets Explanation:

ROA essentially provides an assessment of what the company does with what it’s got; it measures every dollar earned against each dollar’s worth of assets. A business invests in assets for the purpose of generating sales and making a profit. This is what ROA tries to measure. Although assessing ROA depends on the type of business being analyzed, a higher ROA number is generally considered better than a lower one. A higher ratio means that the business is earning more money on its investment in assets.

Return on Assets Example:

Let us, now, calculate ROA using a sample company. Assume the income statement shows net income for period1 as \$558,541 and for period2 as \$637,704. The total asset figures are to be found on the balance sheet as below:

The following chart provides the necessary ROA calculations:

As you can see, although both net income and asset values have increased for the period, the rate of return has decreased. This discrepancy between absolute figures and percentages is precisely why we use the latter. It also reveals a trend in the business. Specifically, although revenue, income, and asset values keep increasing, they can also go down in relative terms.

Regarding our ROA calculations, the ratio for the current year is 23.58%. This essentially means that the business earned almost 24¢ for each dollar invested in assets. This is a decrease from 28¢ in the previous period. Various factors might explain the decrease ranging from an increase in the cost of fixed assets, to an increase in production costs that affect the cost of goods sold directly. In fact, the list of factors contributing to a change in ROA can be almost endless. Some of the most important business decisions by managers pertain to how well resources are allocated. Efficient use of assets should increase ROA. A less productive use of assets can ultimately lead to a decrease in ROA. In essence, ROA measures how efficiently business assets are used relative to profits generated.

As a general rule, an ROA of below 5% is considered capital-intensive or asset-heavy. This means that the business is investing a considerable amount in assets relative to profits. Industries that tend to display low ROA figures include manufacturers and large transportation companies such as railroads. Alternatively, an ROA of over 20% is considered much less capital-intensive or asset-heavy. In other words, such businesses tend to get more ‘bang for the buck’ when it comes to investing in assets. Examples include professional practices, software companies and retailers.

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