The term return on assets (ROA) refers to a financial ratio that indicates how profitable a company is in relation to its total assets. Corporate management, analysts, and investors can use ROA to determine how efficiently a company uses its assets to generate a profit.
The metric is commonly expressed as a percentage by using a company's net income and its average assets. A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits while a lower ROA indicates there is room for improvement.
Understanding Return on Assets (ROA)
Businesses are about efficiency. 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. It tells you what earnings are generated from invested capital or assets.
ROA for public companies can vary substantially and are highly dependent on the industry in which they function so the ROA for a tech company won't necessarily correspond to that of a food and beverage company. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or a similar company's ROA.
The ROA figure gives investors an idea of how effective the company is in converting the money it invests into net income. The higher the ROA number, the better, because the company is able to earn more money with a smaller investment. Put simply, a higher ROA means more asset efficiency.
ROA is calculated by dividing a company’s net income by its total assets. As a formula, it's expressed as:
Return on Assets=Total Assets/Net Income For example, pretend Sam and Milan both start hot dog stands. Sam spends $1,500 on a bare-bones metal cart, while Milan spends $15,000 on a zombie apocalypse-themed unit, complete with costume.
Let's assume that those were the only assets each firm deployed. If over some given period, Sam earned $150 and Milan earned $1,200, Milan would have the more valuable business but Sam would have the more efficient one. Using the above formula, we see Sam’s simplified ROA is $150 / $1,500 = 10%, while Milan's simplified ROA is $1,200/$15,000 = 8%.