Return on Assets (ROA), is a ratio (one figure divided by another) measuring the profitability, expressed as a percentage of the operating assets – it means we are comparing profit to assets. ROA is an indication of a firm’s efficiency to allocate and manage its resources and return a profit, but unlike Return on Equity, ROA ignores the firm’s liabilities. It is also be called Return on Total Investment (ROTI). The formula for how to calculate ROA is:
ROA = Profit (Net Operating income) ÷ Total (Operating) Assets
ROA is displayed as a percentage. Sometimes this is referred to as “return on investment”. Sometimes interest expenses are added back into net income when calculating because they’d like to use operating returns (operating profit) before cost of borrowing is taken into account.
ROA reveals 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. The 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 the assets (investment).
To give an example,
- one company A has a net income of $0.5 million and total assets of $2.5 million, hence 0.5/2.5 and its ROA is 20%;
- another company B earns the same income amount $0.5 million, but has total assets of $10 million, it has an ROA of 5%.
Comparing these examples in the same industry, company A is better at converting its investment into profit.
One would also look at the ROA of each company over the last 3-4 years to see what the trend is – the aim is for managers to excel at making better profits with little investment. That can indicate a good company that is worth investing our money in.
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