Return on Assets ROA Ratio Definition, Formula, and Example

Now, supposing this company lost money or gained assets in excess of their profits, the ROA will become negative. For example, the company purchasing a large piece of equipment for $50,000, will warrant the company using its $20,000 in profit with an additional $30,000 gotten as a financial vs managerial accounting loan. This definitely results in net profits of -$30,000 with assets of $150,000. Therefore, resulting in a ROA of -20 per cent (i.e -$30,000 / $150,000). More so, companies with a low ROA tend to have more debt due to the fact that they need to finance the cost of the assets.

Since all assets are either funded by equity or debt, some investors try to disregard the costs of acquiring the assets in the return calculation by adding back interest expense in the formula. 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. 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.

ROA Example

The return on assets ratio (ROA) measures how effectively assets are being used for generating profit. The main difference between the return on assets ratio and asset turnover ratio is that the return on assets takes into account net income and asset turnover concentrates on revenues. Using net income instead of revenues, the return on assets formula also factors in a firm’s expenses. A good return on assets ratio shows that a company is effective in the management of its assets. A company with a good ROA should be within the range of its peer companies. If an industry has an average ROA of 15% and a company has a ROA of 15.7, it is assumed to manage its assets well in relation to the industry.

Return on Assets is calculated by divided a company’s net income by its total assets. A more sophisticated ROA calculation takes into account that the value of a company’s assets changes over time. To factor this into your calculation, use the average value of assets the company owned in a given year, rather than the total value of its assets at year end. In short, this ratio measures how profitable a company’s assets are. Return on assets indicates the amount of money earned per dollar of assets.

Example of ROA Calculation

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. After all, its total assets include any capital it borrows to run its operations.

This calculation will give you the percentage of net income generated by the use of average total assets. This is a key financial metric used to measure the effectiveness of a company’s management in deploying its assets. A company could have a high ROA, but still be in financial straits because all the assets were paid for through leveraging. Second, the total assets are based on the carrying value of the assets, not the market value. If there is a large discrepancy between the carrying and market value of the assets, the ratio could provide misleading numbers. Companies that operate in capital intensive industries will tend to have lower ROAs than those who do not.

ROA vs Profit Margin Ratio

The return on assets ratio is a way to tell how much profit a company can generate from its assets. Additionally, companies can use the ROA formula to compare their rate with competitors. Because the rates will change from industry to industry, you should only be comparing two companies within the same industry with similar assets. However, if a company were to go under, assets remaining can still be liquidated for a cash value.

In this case, the company invests money into capital assets and the return is measured in profits. The ROA formula is an important ratio in analyzing a company’s profitability. The ratio is typically used when comparing a company’s performance between periods, or when comparing two different companies of similar size in the same 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. 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.