Return on Assets ROA Formula, Example, and Interpretation

She is the author of four books, including End Financial Stress Now and The Five Years Before You Retire. 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. But besides comparisons to industry competitors, another use case of tracking ROA is for tracking changes in performance year-over-year. On the other hand, most mechanical pieces of a business, such as vehicles or other machinery, generally depreciate over time as wear and tear affect their value. Operational costs can include cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

• Furthermore, the calculated ROA is then expressed in percentage form, which allows for comparisons among peer companies, as well as for assessing changes year-over-year.
• Average total assets are used in calculating ROA because a company’s asset total can vary over time due to the purchase or sale of vehicles, land, equipment, inventory changes, or seasonal sales fluctuations.
• A rising ROA may indicate a company is generating more profit versus total assets.
• Put in other terms, a company that posts $1 million in profits of $500,000 in assets is likely a better investment than a company that needs $2 million in capital to make the same amount of money.

EBIT is used instead of net profit to keep the metric focused on operating earnings without the influence of tax or financing differences when compared to similar companies. Because assets and profitability of businesses can vary widely across industries, ROA is typically only useful for comparing similar companies within the same industry. ROI, however, can be used to compare companies in different industries because analysts can use ROI values to determine which company, in any industry, will return the most profits if they choose to invest in it. A ROA that rises over time indicates the company is doing well at increasing its profits with each investment dollar it spends.

Return on Average Assets (ROAA): Definition and How It’s Used

A lower ROA may indicate a company that, while still profitable, nevertheless does less with its money than a comparable firm in the same industry. The first formula requires you to enter the net profits and total assets of a company before you can find ROA. In most cases, these are line items on the income statement and balance sheet.

Examples are gross profit margin, operating profit margin, net profit margin, cash flow margin, EBIT, EBITDA, EBITDAR, NOPAT, operating expense ratio, and overhead ratio. ROAA is similar to ROTA, however ROAA uses net income in the numerator, whereas ROTA uses EBIT (earnings before income and taxes) in the numerator. If return on assets (ROA) uses average assets, then ROA and ROAA will be identical. Analysts often use average assets because it takes into consideration balance fluctuations throughout the year and provides a more accurate measure of asset efficiency over a given time period. Return on assets should not be compared between companies from different industries.

If one were to calculate return on equity in this scenario when profits are positive, they would arrive at a negative ROE; however, this number would not be telling the entire story. It could indicate that a company is actually not making any profits, running at a loss because if a company was operating at a loss and had positive shareholder equity, the ROE would also be negative. In evaluating companies, some investors use other measurements too, such as return on capital employed (ROCE) and return on operating capital (ROOC).

The data below is the ROA of each company from October through December 2018, and it comes from Macrotrends. « The ROA is one indicator that expresses a company’s ability to generate money from its assets, » Katzen says. « Generally speaking, the higher the ROA, the more effective a company is at generating income for investors. The more income a company generates, the more likely the investment will appreciate. » A rising ROA indicates improving efficiency, while an ROA that is falling suggests a company might be spending too much on equipment and other assets relative to the profits it is earning from those investments. Some analysts also feel that the basic ROA formula is limited in its applications, being most suitable for banks. Both interest expense and interest income are already factored into the equation.

What Return on Assets (ROA) Means to Investors

Investors can use ROA to find stock opportunities because the ROA shows how efficient a company is at using its assets to generate profits. The ROA figure gives investors an idea of how effective the company is in converting the money it invests into net income. The higher the ROA number, the better, because the company is able to earn more money with a smaller investment. For example, an auto manufacturer with huge facilities and specialized equipment might have a ROA of 4%.

It measures the level of net income generated by a company’s assets. For example, say you wanted to calculate a company’s ROA over six months. You would take the firm’s reported total assets at the start of the first month. Then you would add it to the reported total assets at the end of the six months and divide it in half. 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.

Return on assets

However, ROAs should always be compared amongst firms in the same sector. For instance, a software maker has far fewer assets on the balance sheet than a car maker. As a result, the software company’s assets will be understated and its ROA may get a questionable boost.

The requirement of assets in Companies from different industries may vary. For example, Auto industries require plant, property, and machinery to generate income as opposed to companies in the service industries. Therefore, companies in the auto industry would have a lower return on assets when compared to companies in the service industry which do not require as many assets as Auto industries. Therefore, return on assets should not be used to compare with companies in a different industry. Shareholder equity is assets minus liabilities on a firm’s balance sheet and is the accounting value that’s left for shareholders should a company settle its liabilities with its reported assets. These measurements are indicators of management’s efficiency with asset use.

Company

Still, these calculations will only give a portion of the total picture. It is critical to utilize a variety of financial metrics to get a full understanding of a company’s financial health before investing. Note that ROE is not to be confused with the return on total assets (ROTA). While it is also a profitability metric, ROTA is calculated by taking a company’s earnings before interest and taxes (EBIT) and dividing it by the company’s total assets.

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. Furthermore, the calculated ROA is then expressed in percentage form, which allows for comparisons among peer companies, as well as for assessing changes year-over-year. Generally, all companies should attempt to maximize the output level with the required spending kept at a minimum – as achieving this means the company is operating near full capacity and efficiency. « Generally speaking, an ROA of 5% or better is considered ‘good,' » Katzen says. « But it is important to consider a company’s ROA in the context of competitors in the same industry, the same sector and of similar size. »

During the current year, Charlie’s company had net income of $20,000,000. The net income is the bottom-line profit—before common-stock dividends are paid—reported on a firm’s income statement. Free cash flow (FCF) is another form of profitability and can be used instead of net income. It’s useful for an investor to learn how to calculate a financial ratio known as « return on assets » (ROA). This is a management-performance ratio that is generally used to compare different companies and the uses of their assets. Return on assets (ROA) is a measure of how efficiently a company uses the assets it owns to generate profits.

It tells you what earnings are generated from invested capital or assets. The return on assets ratio measures how effectively a company can earn a return on its investment in assets. In other words, ROA shows how efficiently a company can convert the money used to purchase assets into net income or profits. A company’s balance sheet will often report the average level or value of assets held over an accounting period, such as a quarter or fiscal year. It is often calculated as beginning assets less ending assets divided by two. This is done because on any given day, a firm’s actual level of assets will fluctuate in the course of doing business.

During the same period, the company’s 12 monthly balance sheets reported an average of $1,000,000 in total assets. The company’s return on assets ratio for the year was 6% ($60,000 divided by $1,000,000). They show how well a company utilizes its assets to produce profit and value to shareholders. There are two ways to calculate return on assets — by using net income and total assets and by using net profit margin and asset turnover. All the numbers needed in these calculations can be obtained from a company’s financial statements.

This ROA is more accurate than the 6.49% figure in the example above. For the “Upside Case”, the company’s return on assets (ROA) increases from 10.0% to 12.5% – which implies more efficient resource allocation, causing increased net earnings. Simply put, companies with a consistently higher return on assets ratio (ROA) can derive more profits using the same amount of assets as comparable companies with a lower return on assets ratio. In circumstances where the company earns a new dollar for each dollar invested in it, the ROTA is said to be one, or 100 percent.

Below is the balance sheet from Exxon’s 10K statement showing the 2021 and 2020 total assets. Note the differences between the two, and how this will affect the ROA. ROA is shown as a percentage, and the central payroll bureau higher the number, the more efficient a company’s management is at managing its balance sheet to generate profits. It is important to note that return on assets should not be compared across industries.

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. Both ROA and return on equity (ROE) measure how well a company utilizes its resources. But one of the key differences between the two is how they each treat a company’s debt. ROA factors in how leveraged a company is or how much debt it carries.

Average total assets are used in calculating ROA because a company’s asset total can vary over time due to the purchase or sale of vehicles, land, equipment, inventory changes, or seasonal sales fluctuations. As a result, calculating the average total assets for the period in question is more accurate than the total assets for one period. Assume that during its most recent year, a company’s income statement reported net income of $60,000.