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Return on Assets & ROA Formula

The ability of a company to generate returns on its total assets

ROA Formula / Return on Assets Calculation

Return on Assets (ROA) is a type of return on investment (ROI) that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit it’s generating to the capital it’s invested in assets.  The higher the return, the more productive and efficient management is in utilizing economic resources. Below you will find a breakdown of the ROA formula and calculation.

 

return on assets example

 

What is the ROA Formula?

The ROA formula is:

ROA = Net Income / Average Assets

or

ROA = Net Income / End of Period Assets

 

Where:

Net Income is equal to net earnings or net income in the year (annual period)

Average Assets is equal to ending assets minus beginning assets divided by 2

 

roa formula example

 

Example of ROA Calculation

Let’s walk through an example step by step of how to calculate return on assets using the formula above.

Q: If a business posts a net income of $10 million in current operations, and owns $50 million worth of assets as per the balance sheet, what is its return on assets?

A: $10 million divided by $50 million is 0.2, therefore the business’s ROA is 20%. For every dollar of debt and equity the business takes on, it can return 20 cents in net profit (after all deductions).

For every dollar of assets the company invests in, it returns 20 cents in net profit per year.

 

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What is the Importance of Return on Assets?

The ROA formula is an important ratio in analyzing a company’s profitability. The ratio can be used when comparing a company’s performance between periods, or between two different companies of similar size and industry.

Note that it is very important to consider the scale of a business and the operations performed when comparing two different firms using ROA.

For example, a business that is capital-intensive and possessing high value fixed assets will see a higher asset base than a similar business with a lower asset base. Though the two may earn similar income, the business that is more capital-intensive may have a lower ROA due to the larger denominator.

 

What is Net Income?

Net income is the net amount realized by a firm after deducting all the cost of doing business in a given period. It includes all interest paid on debt, income tax due to the government, and all operational and non-operational expenses.

Operational costs can include cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property.

Also added into net income is the additional income arising from investments or those that are not directly resulting from primary operations, such as proceeds from the sale of equipment or fixed assets. Note: non-operating items may be adjusted out of net income by a financial analyst.

Net income/loss is found at the bottom of the income statement and divided into total assets to arrive at ROA.

 

Return on Assets for Companies

 

1. Using ROA to determine profitability and efficiency

Return on assets indicates the amount of money earned per dollar of assets. Therefore, a higher return on assets value indicates that a business is more profitable and efficient.

 

2. Using ROA to compare between companies

It is important to note that return on assets should not be compared across industries. Companies in different industries vary in their use of assets. For example, some industries may require expensive plant, property, and equipment to generate income as opposed to companies in other industries. 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.

 

3. Using ROA to determine asset-intensive/asset-light companies

Return on assets can be used to gauge how asset-intensive a company is:

  • The lower the return on assets, the more asset-intensive a company is. An example of an asset-intensive company would be an airline company.
  • The higher the return on assets, the less asset-intensive a company is. An Example of an asset-light company would be a software company.

 

As a general rule, a return on assets under 5% is considered an asset-intensive business while a return on assets above 20% is considered an asset-light business.

 

Return on Assets in Financial Analysis

ROA is commonly used by analysts performing financial analysis of a company’s performance.

ROA is important because it makes companies more comparable. Imagine two companies… one with a net income of $50 million and assets of $500 million, the other with a net income of $10 million and assets of $15 million.

Which company would you rather own?

The first company earns a return on assets of 10% and the second one earns an ROA of 67%.

 

 

Additional Resources

Thanks for reading CFI’s guide to return on assets and the ROA formula.  To keep learning and become a world-class financial analyst, these additional resources will be a big help:

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