In our Masterclass today we look at Return on Assets – ROA, which is a ratio (one figure divided by another) measuring the profitability of a (non-financial) firm, expressed as a percentage of the operating assets – ie comparing profit to assets. ROA indicates a firm’s efficiency to allocate and manage its resources but unlike return on equity ROA ignores the firm’s liabilities. It can also be called return on total investment (ROTI). The formula to calculate is:
Profit (Net Operating Income) ÷ Total (Operating) Assets
This indicates how profitable a company is compared to its total assets. ROA is displayed as a percentage. Sometimes this is referred to as “return on investment”. Sometimes interest expense is added back into net income when calculating because they’d like to use operating returns before cost of borrowing.
ROA tells you what earnings were generated from invested ASSET capital. ROA for public companies can vary substantially and is very dependent on the industry of the business, so it is best to compare it against a company’s previous ROA numbers or the ROA of a similar company in that industry.
The assets of the company can be expressed as containing both debt and equity. Both of these are types of financing and are used by business managers to fund the operations of the company. ROA figure gives investors an idea of how effectively the company is converting the money it has to generate into profit/net income return. The higher ROA is, the better, because the company is earning more money on less assets (investment).
To give an example:
- One company A has a net income of $0.5 million and total assets of $2.5 million, its ROA is 20%;
- Another company B earns the same amount $0.5 million, but has total assets of $10 million, it has an ROA of 50%.
Comparing these examples, company A is better at converting its investment into profit.
The aim is for managers to excel at making large profits with little investment.
What are your thoughts? Start or continue the conversation here!