What is Return on Assets?
Return on Assets is one of the efficiency ratios that use to measure and assess how efficiently the company’s assets are being used. The main indicators to measure the efficiency of assets in this ratio are Net Income and Total Assets.
Return on assets is calculated by using net income over the total assets that the entity uses to generate that Income.
This ratio could be used in the company where assets are the main resources that use to generate revenue. For example, a manufacturing company or hotel.
However, this ratio is not suitable to use to assess the company where assets are not the main revenue generator. For example, consultant or services companies.
The formula of Return On Assets : Net Income / ( Total Assets)
- Finding the Net Income is not as hard as it is normally provided in the income statement. Net Income is normally at a specific period of time. If you do a benchmark by comparing the ROA of one profit centre, investment centre or company. It is a good idea to select the Net Income in the same period of time. Otherwise, your analysis is non-sense.
- For Total Assets, sometimes they use Average Total Assets. The most recommended is when the Average Total Assets are available, then it is recommended to select, but if it doesn’t, let use Total Assets. Whatever you use, there must be consistency.
What do I mean by that?
Well, let say you are comparing two investment centre of their Return on Assets. Then you should select the net income from the same period of time and the same nature of assets, say Total Assets.
Okay, now you have learned about the formula and explanation of Return on Assets. Let move to the example together,
Example and Calculation:
The following is the example of Return on Assets and to calculate it.
ABC Company has Not Income: USD 50,000,000 for the period 1 January to 31 December 2016 and the Total Assets at the end of 31 December 2016 was USD100,000,000. The total Assets at the beginning of the years was USD 90,000,000.
ABC Company is operating in the manufacturing industry and the Industry Average of ROA is: 1 Previous year, ROA of ABC Company was: 1.05.
Discuss ROA of ABC Company.
Based on the formula about, the ROA is Net Income / ( Total Assets). As per the scenario, the Total Net Income for the year is USD 50,000,000. For Total Assets, in this case, we use Average Total Assets because the previous year Total Assets is available.
Average Total Assets is (USD 100,000,000/ USD 90,000,000)/2 = USD 95,000,000
Therefore, ROA = USD 50,000,000/ USD 95,000,000 = 0.52 or 52%
Return On Assets as Performance Measurement
In this part, we will discuss on the using of Return on Assets of Performance Management. This also include the advantages and disadvantages of using ROA.
As mention above, Return On Assets is used to measure the efficiency of assets using to generate the Net Income, and this is the Financial Indicators which normally use in the manufacturing industry.
This Return on Assets is normally benchmark with the industry average, competitor, and previous year. For better analysis, the trend of this ratio for at least three years would be more beneficial.
There are advantages and disadvantages of using ROA as a performance indicator in order to assess the company’s performance as well as to reward management.
For the advantages, the ROA uses the percentage, therefore, we could compare it to the other companies that have different size of assets. ROA also very to understand by non-accounting managers and also it is very easy to calculate.
Besides advantages, there are also many disadvantages to using ROA as performance indicators. ROA using accounting information for calculation and it is commonly affected by management judgment.
Accounting policies is one among those factors. ROA uses percentage but it does not show the real value added to the shareholders or the company.
The serious disadvantages of ROA are it motivate management to use the old assets and discourage them not to invest in the new assets.
Interpretation and Deep Analysis:
Now, let see how is this ROA mean to ABC Company.
Based on the calculation about, current ROA is only 0.52 while the previous year ROA was 1.05. Based on this ratio, we can say that the current performance is poor than the previous year in term of efficiency ( using assets to generate revenue).
This might be because of low productivity, decreasing demand or highly competitive in the market. However, compared to the industry average, ROA is 1, ABC Company still not performing well enough.
There are many reasons why ROA of ABC Company is decreasing. First, probably not all of the company assets are using.
Let say, their many machines are idle assets as the result of the low purchase order or no technical personnel stand by to control those machines. These could cause the company to generate less profit than the previous year and the industry average.
Another reason is the accounting technique used by the management of the company. ROA is significantly affected by accounting policy or it can simply mean management could trick on accounting policies to get the accounting result as they want.
For example, Not Income is affected by accounting depreciation which is mainly based on judgment.
An additional reason why the ROA of the company is decreasing probably because of this year managements have disposed many of the old assets and replace them the new one.
This movement of assets could cause a large amount of depreciation being a charge to these years and result from decrease Net Income.
For better analysis and interpretation, all of the factors internal and external effect on the ROA should be included and taking into account like demand in the market or ROA of industry average as well as competitors.
Some internal factors like using old assets, replacement and changing the accounting policies also significantly affect ROA.
The return on assets ratio, often called the return on total assets, is a profitability ratio that measures the net income produced by total assets during a period by comparing net income to the average total assets. In other words, the return on assets ratio or ROA measures how efficiently a company can manage its assets to produce profits during a period.
Since company assets’ sole purpose is to generate revenues and produce profits, this ratio helps both management and investors see how well the company can convert its investments in assets into profits. You can look at ROA as a return on investment for the company since capital assets are often the biggest investment for most companies. In this case, the company invests money into capital assets and the return is measured in profits.
In short, this ratio measures how profitable a company’s assets are.
The return on assets ratio formula is calculated by dividing net income by average total assets.
This ratio can also be represented as a product of the profit margin and the total asset turnover.
Either formula can be used to calculate the return on total assets. When using the first formula, average total assets are usually used because asset totals can vary throughout the year. Simply add the beginning and ending assets together on the balance sheet and divide by two to calculate the average assets for the year. It might be obvious, but it is important to mention that average total assets is the historical cost of the assets on the balance sheet without taking into consideration the accumulated depreciation.
The net income can be found on the income statement.
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.
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.
It only makes sense that a higher ratio is more favorable to investors because it shows that the company is more effectively managing its assets to produce greater amounts of net income. A positive ROA ratio usually indicates an upward profit trend as well. ROA is most useful for comparing companies in the same industry as different industries use assets differently. For instance, construction companies use large, expensive equipment while software companies use computers and servers.
Charlie’s Construction Company is a growing construction business that has a few contracts to build storefronts in downtown Chicago. Charlie’s balance sheet shows beginning assets of $1,000,000 and an ending balance of $2,000,000 of assets. During the current year, Charlie’s company had net income of $20,000,000. Charlie’s return on assets ratio looks like this.
As you can see, Charlie’s ratio is 1,333.3 percent. In other words, every dollar that Charlie invested in assets during the year produced $13.3 of net income. Depending on the economy, this can be a healthy return rate no matter what the investment is.
Investors would have to compare Charlie’s return with other construction companies in his industry to get a true understanding of how well Charlie is managing his assets.
Return on assets measures how effectively a company uses its assets to generate income. It is roughly equivalent to an investor’s overall portfolio rate of return.
To calculate return on assets, add interest expense back to net income, and divide by average total assets.
|Subcategory, Other revenue and expenses|
|Gain on sale of investments||$137,000|
|Income before income tax||$314,000|
|Income tax expense||66,000|
|Net income||Single Line $248,000 Double Line|
|Total current assets||$911,000||$800,000|
|Subcategory, Long-term investments:|
|Investment in equity securities||$1,946,000||$1,822,000|
|Subcategory, Property, plant and equipment:|
|Total property, plant and equipment||$1,093,000||$984,000|
|Total assets||Single Line $3,950,000 Double Line||Single Line $3,606,000 Double Line|
In our hypothetical example, net income is $248,000. Interest expense relates to financed assets, and it is added back to net income since how the assets are paid for should be irrelevant. This also makes the calculation more comparable between companies that use debt financing and companies that use equity financing.
Adding back $55,000 in interest expense gives us $303,000 in investment income, divided by $3,778,000—the average of beginning and ending total assets [latex]=\dfrac<\left(3,950,000+3,606,000\right)><2>[/latex]—equals a rate of return on assets of .08020116 or roughly 8%. The higher the rate of return, the better, and this will vary from industry to industry and also according to current economic conditions. For instance, if the Federal Reserve is using monetary policy to depress overall interest rates, 8% might be a good rate of return. If however, the stock market is returning 10% or better, an 8% rate of return might not be appealing to an investor.
However, as with any high-level metric, this ratio has to be considered both in a larger context (e.g. over a long period of time) and as part of a larger analysis (e.g. other metrics, such as earnings per share or dividend payout may still make this an appealing investment.)
Now that you have learned about the rate of return on total assets, let’s practice your understanding.
The return on assets ratio (ROA) for any individual company shows how effectively it has turned its investments into profits. The model uses the simple formula of net income divided by total assets. A company that has a higher ROA has made comparably more profit for the investment either the owners or individual investors have made. However, the formula must be interpreted knowledgeably in order for one to truly understand the success of the company’s management at turning a profit.
To understand ROA, use this example. Sam’s Internet company earns $1,000 a year. Sarah’s magazine earns $10,000 a year. To most people, investing in Sarah’s company would seem like a much better option at first glance. However, a knowledgeable investor asks Sam the total value of his assets, i.e., how much he paid to start his company’s operations. Sam’s assets total $100; this is the cost he incurred to set up his website. His ROA, then, is 100 percent, which is extremely high. The same investor asks Sarah the total value of her assets. She explains she required $20,000 from investors in order to obtain the equipment to print her magazine. Her ROA is only 50 percent. Therefore, an investor who places $100 in Sam’s company will make more in return on that $100 in a single year than an investor who places the $100 in Sarah’s company.
Debt to Equity Consideration
One important factor to understand when analyzing ROA is the fact that both equity and debt count as assets in the calculation. In the above example, if Sarah invested $10,000 of her own money and took $10,000 in loans, all $20,000 would count as her assets. However, it is clear to see that she is operating at a very high debt ratio. This could expose her to bankruptcy if a slow sales cycle were to occur. Always consider how much of a company’s assets are in debt when looking at this ROA ratio. A company with a slightly lower ROA but far less debt than another company may be a more advantageous and safer investment.
Some industries continue to operate with very low ROAs. For example, the automobile industry has an extremely high cost of entry. To begin making cars, a company must invest millions of dollars in equipment and factories, raising its total assets. However, the Internet sales industry is on the exact opposite end of the spectrum. A company like Google or eBay can start up with very little capital investment. Therefore, some industries will permanently operate at higher ROAs than others. This does not mean you should not invest in automobile manufacturers. It does mean, though, that you should compare one manufacturer to another in its own industry if you are considering ROA as a factor in your investment. Within an industry, a company with a higher ROA will be, for the most part, a more profitable company. Using this figure in addition to factoring in debt to equity ratios can give you a clear picture of how well an individual business manages its assets and puts them to work.
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The return on investment ratio (ROI), also known as the return on assets ratio, is a profitability measure that evaluates the performance or potential return from a business or investment. The ROI formula looks at the benefit received from an investment, or its gain, divided by the investment’s original cost.
Defining the Ratio
ROI serves as a returns ratio, allowing a business owner to calculate how efficiently the company uses its total asset base to generate sales. Total assets include all current assets such as cash, inventory, and accounts receivable in addition to fixed assets such as the plant buildings and equipment.
If an investment doesn’t have a good ROI, or if an investor or business owner has other opportunities available with a higher ROI, then calculating the ROI values on the different opportunities can instruct them as to which investments to choose for the best return.
Many analysts and investors like to use the ROI metric because of its versatility and simplicity. Essentially, it works as a quick gauge of an investment’s profitability, and it’s very easy to calculate and interpret for a wide variety of investment types.
Calculating the Return on Investment
You can determine ROI in different ways, but the most frequently used method involves dividing net profit into total assets. The return on investment ratio is also called the return on assets ratio because that investment refers to the firm’s investment in its assets.
Calculate the ratio as follows:
Investment gain (Net Income) / Cost of Investment (Total Assets) = X%
where Net Income comes from the income statement and Total Assets come from the balance sheet.
Interpretation of the Results
To interpret the ROI percent results, collect appropriate, comparative data such as trend (time series) or industry data on ROI. The business owner can look at the company’s ROI across time and also at industry data to see where the company’s return on investment ratio lies. The higher the return on investment ratio, the more efficiently the company is using its asset base to generate sales.
Say that Joe invested $1,000 in his start-up, Joe’s Super Computer Repair. He has a buyer for the business for $1,200. The ROI for this equals Joe’s profit or $200 divided by his initial investment, $1000, for a 20% ROI.
Joe also invested $1,000 in Sam’s New Computer Sales, and a buyer is looking to pay $1,800. The ROI for this equals the $800 profit divided by his investment of $1,000, or 40%. From this comparison, selling Sam’s New Computer Sales appears to be the wiser move, with 20% vs. 40%.
The Time Factor
What the ROI formula doesn’t tell you, and one of the short-comings of the ROI ratio is the time involved. This metric can be used in conjunction with the rate of return on an asset or project, which does consider the period of time.
You can also incorporate the net present value (NPV), which accounts for differences in the value of money over time due to inflation, for even more precise ROI calculations. The application of NPV when calculating the rate of return is often called the real rate of return.
The Return on Net Assets (RONA) is a performance ratio, which compares the income generated by a business and the fixed assets used to generate the income. Hence, it measures the efficiency of a company in generating returns on the assets it owns.
Definition: What is Return on Net Assets (RONA)?
For many companies, fixed assets are the biggest component of investment. Hence, it is useful to understand how much income these assets are producing. It’s also useful to understand if the company is effectively deploying its resources or losing money on incremental investments. It can also provide sense of the time period in which a new investment can be returned to the investors. Better utilization of assets can generate higher returns making the company more profitable and increasing the ability of the company to return the money to investors.
Although there are no fixed standards for RONA, generally the higher this ratio is the better it is. Higher RONA may imply that the company is using its assets efficiently and effectively. Also an increasing RONA may indicate an improving profitability and financial performance of a company.
Let’s see how to calculate the return on net assets.
The return on net assets formula is calculated by dividing net income by the sum of fixed assets and working capital.
Return on Net Assets = Net Income / (Fixed assets + working capital)
In a manufacturing sector, plant specific RONA can be calculated as:
Return on Net Assets = (Plant revenue – costs) / (Fixed assets + working capital)
Most of the items in the first RONA equation can be found in the annual report of a company. You may have to look beyond balance sheet and Income statement and into notes to accounts and discussion section to get more granularities of the items.
For the second formula, we will need in-depth management information at plant level, which might not be public information. This formula is used by company management or M&A analyst.
Net Income is bottom line of the income statement of a company and implies Sales less all expenses attributable to running the operations of a company.
Net Assets considers all the fixed assets of a company plus the net working capital. Net Working capital is current assets minus current liabilities.
Manufacturing companies maintain plant level information on sales, operating costs and assets. This data can be used to calculate RONA of every plant.
Having described the basic concept and formula for RONA, let us look at some examples to understand the concept in a better manner.
Let’s look at an example.
In the financial data presented in the table below, we have calculated RONA for three years for a hypothetical company A. The results are also summarized along with the data. As is obvious, the ratio has been improving as the Net income value has improved faster than the Net assets. Analysts need to dig deeper into understanding the reason for this increase and if it is sustainable.
Let us look at couple of examples in the automotive industry: GM and Ford. These companies have undergone several operational changes and restructuring. After the 2008 financial crisis US automotive sector was badly hit by slowing sales and labor issues. There asset productivity was badly impacted. However, the companies have taken cost reduction initiatives and disposal of non-core assets which have helped them improve RONA. Year-on-year RONA is also impacted by one-off events such as in the case of GM which had some recalls in 2014 thus incurring exceptional costs.
Analysis and Interpretation
RONA is an important tool to measure the asset utilization of a company. Especially for manufacturing companies with multiple plants, it is very important for the management to gauge the performance of each plant. Management might want to track the performance of each plant over several years and compare it with the initial goal. If a plant is not profitable, then they might want to look at various steps to improve the performance or shutdown the plant.
Analyst should track the RONA of a company across long-term and compare it with peers. However, the number alone doesn’t tell anything. It needs to be look from business strategy point of view. If the company has faced restructuring, litigations, plant closures, than in the short period RONA might decline. However, over longer term it should revert to its historical average or future management projections.
Since RONA depends on the profit margin and the amount of asset deployed by a company, this ratio should always be looked at from peers in the same industry. In the above example, GM has been able to reduce its cost significantly, while maintaining its core-assets. However, the RONA levels in 2015-16 might not be sustainable, and this is something to be considered by an analyst.
Management might not give a direct guidance on RONA, but it does comment on the capital investment plan and profitability targets. Analyst should analyze if these guidance are achievable and if so, how does it impact the profitability ratios like RONA. It can be causes of concern if the ratio is expected deteriorate in future.
Practical Usage Explanation: Cautions and Limitations
It’s important to not get tunnel vision when analyzing a company. A single metric isn’t going to give you a complete view of a company financial status. Thus, some other useful ratios that you should look at when analyzing a company’s returns are Return on Equity (ROE), Return on Assets (ROA), and Return on Capital Employed (ROCE).
One thing to remember is that RONA doesn’t calculate a company’s future ability to create value. If you wanted to do that, you would need to add extraordinary expenses to the net income for future calculations. This doesn’t tell anything about the future RONA of a company, rather it gives a broad picture of what to expect if the status quo is maintained.
Like with any balance sheet number, we need to be careful about the use of historical value of the assets. These values might not represent the replacement cost and hence the true picture of the asset utilization.
In conclusion, RONA provides useful insights in the management of a company. It should be considered in context of the business cycle and company specific considerations.
By Madhuri Thakur
Return on Assets Formula (Table of Contents)
Return on Assets Formula
Return on Assets (ROA) can be helpful in determining the profitability and efficiency of a business – ROA shows how much money will be earned by investing a dollar of assets. Higher the ROA shows that the company is utilizing its assets efficiently. This ratio shows how well a company is performing through comparing the investment in assets with its profitability.
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The formula for calculating Return on Assets (ROA) is as follows:
- Net Income: it is equal to net earnings in a financial year.
- Average Total Assets: it is equal to a sum of total assets for the current year and total assets for the previous year divided by two.
Examples of Return on Assets Formula
Let’s see an example to understand Return on Total Assets:
Jagriti Capital Inc shows a net income of $20 million in current operation and owns $20 million worth of assets at the beginning of the year and $25 million worth of assets at the end of the year as per the balance sheet. Now, what is the return on assets Jagriti Capital Inc.?
We can calculate Return on assets by using the formula:
ROA = Net Income / Average Total Assets
- Net Income = $20 Million
- Average Total Assets = (Assets at the beginning of the year + Assets at the end of the year)/2
- i.e. Average Total Assets = $ (20 + 25) / 2
- Average Total Assets = $ 22.5 Million
- ROA = Net Income / Average Total Assets
- ROA = $ (20/22.5)
- ROA = 0.89
Explanation of Return on Assets Formula
To Calculate Return on Assets (ROA), we need Net Income and Average Total Assets
The first component is Net Income.
Net income is the total net amount realized by a company after deducting all the business cost for a given period. It includes all operational and non-operational expenses, tax paid to the government and interest paid on the debt. Operational costs include the cost of goods sold, the direct cost of production, General administrative & marketing expenses, depreciation & amortization on fixed assets. Net income also includes any additional income rising through investments or any other source than the company’s primary operations, such as proceeds from the sale of fixed assets. Net income/loss can be found at the bottom of the income statement of any company.
The second component is Average Total Assets.
Average total assets can be calculated as the sum of assets at the beginning of the year and assets at the end of the year divided by 2. Opening and Closing amount of total assets are available in the balance sheet of any company.
To calculate the Return on Assets Formula, we need to compare the Net Income to the Average Total Assets. i.e., ROA = Net Income / Average Total Assets
Significance and Use of Return on Assets Formula
Return on Assets formula is an important ratio which is used for analyzing company’s profitability. This can be used for comparing a company’s performance with different companies of similar size & industry or else can be used to compare the current performance of the company with its previous performance. Few things to keep in mind before comparing the companies on the basis of Return on Assets. i.e., Size, Scale and Industry of the companies must be the same.
Return on assets should not be compared between the companies from different industries. 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 industries 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.
Return on Assets (ROA) can be helpful in determining the profitability and efficiency of a business – ROA shows how much money will be earned by investing a dollar of assets. Higher the ROA shows that the company is utilizing its assets efficiently. Return on Assets (ROA) can be used to determine the structure of the company. i.e., Whether the company is an asset-intensive or an asset-light company.
Asset-intensive companies will have a lower return on assets. Example for Asset-intensive companies is Auto company, Airline company, etc. Whereas, Asset-light company will have a high return on assets. Example of an asset-light company can be a software company. As per Industry standards, An Asset-intensive company has a return on assets under 5% and an asset-light company has return on assets above 20%.
Return on Assets Calculator
You can use the following Return on Assets Calculator
Return on Assets Formula in Excel (With Excel Template)
Here we will do the same example of the Return on Assets formula in Excel. It is very easy and simple. You need to provide the two inputs i.e Net Income and Average Total Assets
You can easily calculate the Return on Assets using Formula in the template provided.
First, we need to calculate the Average Total Assets.
then we calculate Return on Assets using formula.
This has been a guide to a Return on Assets formula. Here we discuss its uses along with practical examples. We also provide you with Return on Assets Calculator with downloadable excel template. You may also look at the following articles to learn more –
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This is an ultimate guide on how to calculate Return on Assets (ROA) ratio with in-depth interpretation, analysis, and example. You will learn how to use its formula to evaluate a company’s profitability.
Definition – What is Return on Assets Ratio (ROA)?
When you’re considering investing in a company, you want to feel confident that the business in question is performing effectively enough to generate the greatest returns possible, with the fewest assets.
By calculating a firm’s ROA, you can measure its net earnings against its total assets to determine just how successfully it’s using its resources to profit from its regular business operations.
Not only will this process allow you to judge how efficient a company’s management team is at generating earnings, it can also indicate just how capable the company is of funding its own growth and expansion.
Considering the fact that the entire purpose behind a firm’s assets is to produce revenue, the return on total assets ratio should play a critical role in your evaluation of any potential investment.
So what is the return on asset formula? You can easily calculate a company’s ROA by using the following equation:
Return on Total Asset Ratio = Net Income / Total Assets
A company’s net, after-tax income can usually be found on its income statement for a given period, while its total assets amount is reported on its balance sheet.
Many investors prefer to average a firm’s total assets, since this amount can fluctuate over the course of a reporting year.
To do this, you would simply add the opening and closing annual asset amounts together, and divide by 2.
Return on Assets (ROA) Calculator
Okay now let’s have a look at a quick example so you can know how to find return on total assets ratio in real life.
Perhaps you are considering investing in Company FF, and you want to find out how efficiently its management team has been using company assets to turn a profit.
To calculate Company FF’s return on asset ratio for the past three years, you would use the given ROA formula and the appropriate figures from its balance sheets and income statements to devise a comparison, as follows:
From these results, you can see that Company FF has been steadily generating a positive return on its assets for the past several years.
Interpretation & Analysis
Now that you understand the ROA equation, let’s find out how to use this ratio to analyze a company’s profitability.
So what is considered a good return on assets?
A higher return on asset ratio is generally a more desirable outcome, since it means that a business is handling its resources more effectively in the production of income.
The higher the result of the ratio, the more profitable a company’s assets are.
In effect, you could simply consider a firm’s resources as a vehicle for converting investment dollars into profit.
You should bear in mind, however, that different industries have different asset requirements.
Those that rely heavily on expensive equipment, such as the construction industry, will demonstrate a very different return on assets ratio than those that operate with relatively few assets, like the consulting or marketing sectors.
It’s important to use this ratio to compare companies within the same industry, and/or to track a single firm’s profit trend over a period of time.
Cautions & Further Explanation
Calculating the return on total asset ratio for a given company relies on working with an accurate reckoning of its total assets.
But this amount is generally based on historical cost, and some companies hang onto their major assets, such as specialized equipment, for many years.
Because these types of material resources depreciate over time, the long-term portion of the asset figure may not be as precise as it should be, and it can effectively skew the results of the return on asset ratio calculation.
While most short-term asset amounts, such as inventory, can be assessed with relative accuracy, you may want to consider substituting a depreciated or current value for those assets that make up a large portion of a firm’s longer-term holdings.