A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits. Investors should analyze what factors are driving ROA up or down over the time series. ROA fluctuates due to macroeconomic conditions, industry trends, management decisions, production changes, and more.

Related Terms

At its core, the ROA ratio offers a snapshot of a company’s profitability relative to its total assets. It is calculated by dividing a company’s net income by its total assets. The resulting percentage indicates how much profit is generated for every dollar of assets owned by the company.

• ROA measures profitability relative to total assets, while ROE focuses on profitability relative to shareholders’ equity.
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• However, industry averages have limitations since they lump both high and low performers together.
• Having more debt is not bad as long as management uses it effectively to generate earnings.

Looking beyond direct competitors, investors also compare the company to industry leaders with the highest ROA. The gap between the company’s ROA and industry leaders indicates how much asset profitability could potentially improve. For example, a company with an ROA of 10% compared to a leading competitor’s ROA of 15% signals an opportunity to enhance competitiveness through more efficient asset usage. If the return on assets is increasing, then either net income is increasing or the average total assets are decreasing. The simplest way to determine ROA is to take net income reported for a period and divide that by total assets. To get total assets, calculate the average of the beginning and ending asset values for the same time period.

Difference Between Return on Assets and Return on Equity

Total assets are also the sum of its total liabilities and shareholder equity because of the balance sheet accounting equation. A company’s assets are either funded by debt or equity, so some analysts and investors disregard the cost of acquiring the asset by adding back interest expense in the formula for ROA. While evaluating a company’s ROA, it’s important to compare it against competitors in the same industry and against the company’s own historical trends. It indicates it is more efficiently using its assets to generate profits if a company’s ROA is higher than its peers.

Interpreting the Return on Assets

Understanding the underlying causes provides crucial context for anticipating future ROA shifts. Investors should also compare the company’s ROA trend to competitors in the same industry over the same timeframe. This competitive benchmarking reveals whether the company is outperforming or underperforming rivals in efficiently using assets to generate profits.

This is a pure measure of the efficiency of a company in generating returns from its assets without being affected by management financing decisions. It is important to note that return on assets should not be compared across industries. Companies in different industries vary significantly in their use of assets. For example, some industries may require expensive property, plant, and equipment (PP&E) to generate income as opposed to companies in other industries. Improving ROA generally involves either increasing net income or more efficiently using assets.

How to Use Return on Assets

When you divide the company’s net profit of $2,500,000 by $33,500,000, you get a ROA of 7.46%. This ROA is more accurate than the 6.49% figure in the example above. The money the company earns from selling widgets minus the cost of materials and labor equals its net profit. Divide the company’s net profit by the value of its assets to get ROA. If it has a low ROA, then it isn’t effectively generating enough money on the assets it owns.

A typical financial assessment tool, ROA, shows the company’s health level to investors and stakeholders through percentage data analysis. An enterprise with greater ROA yields better returns on its resource investment for creating profits. A reduced ROA rate reveals that the business fails to use its resources efficiently. Return on assets (ROA) is a measure of how efficiently a company uses the assets it owns to generate profits. Managers, analysts and investors use ROA to evaluate a company’s financial health.

• When you divide the company’s net profit of $2,500,000 by $33,500,000, you get a ROA of 7.46%.
• A high ROA indicates a company is generating strong profits relative to its assets, suggesting its management is using resources efficiently.
• This simple “bang-for-the-buck” approach highlights why ROA is a widely used measure of business efficiency.
• Her background in education allows her to make complex financial topics relatable and easily understood by the layperson.
• This scenario suggests that while the company is good at generating sales, it may struggle with controlling costs or converting those sales into profit.

Since it adjusts for the scale of asset bases, ROA allows investors to contrast both large-cap and small-cap firms in the same sector on an apples-to-apples basis. The company exhibiting superior ROA is better at deploying assets profitably, indicating strengths in brand, scale, costs, or execution. Understanding this concept helps determine which stocks have advantages. Secondly, evaluating ROA trends helps identify promising stock opportunities that are improving asset productivity. Firms with rising ROA are becoming more capable of extracting income growth from their asset base.

ROA is typically expressed as a percentage, making it easier to compare across companies. Emily Guy Birken is a former educator, lifelong money nerd, and a Plutus Award-winning freelance writer who specializes in the scientific research behind irrational money behaviors. Her background in education allows her to make complex financial topics relatable and easily understood by the layperson. She is the author of four books, including End Financial Stress Now and The Five Years Before You Retire. We accept payments via credit card, wire transfer, Western Union, and (when available) bank loan.

On the flipside, say you invested money into the business to buy more equipment. As your assets have increased, you’ll want to know how your ROA has been impacted. If your ROA increased or stayed the same, then you know that your business was efficient at turning those new assets into profit.

Why is ROA important to understand?

A rising ROA indicates that a company is generating more profit from its assets. But there can also be other factors involved, so it’s helpful to look back over multiple years. A dip in ROA for a single year may be nothing to worry about, but a consistent downward trend calls for a good explanation. For that reason, it can often be useful to compare a company’s ROA over multiple accounting periods. One year of a lower ROA may what does roa stand for in finance not be a concern if the company’s management team is investing in its future and the company anticipates increased profits over the coming years.

ROA improves the cost of debt and is excluded if a company borrows at lower interest rates than it generates from asset returns. Investors should factor in leverage and risk-adjusted returns, not just asset returns. Imagine two companies… one with a net income of $50 million and assets of $500 million, the other with a net income of $10 million and assets of $15 million. Operational costs can include cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property. Typically, an ROA greater than 5% is considered good, but this is just a general rule of thumb.

ROA factors in how leveraged a company is or how much debt it carries. Its total assets include any capital it borrows to run its operations. Instead of compiling the data directly, financial databases are used to look up pre-calculated ROA ratios for public companies. Platforms like Bloomberg, Capital IQ, FactSet, and Morningstar report key financial ratios derived from income statements and balance sheets.