Return on Assets (ROA) is a ratio designed to measure the efficiency of a company’s management. It indicates the company’s profitability as compared to its assets. This gives the analyst an insight into how effectively the company is managing its resources.
The Return on Assets can be calculated by dividing the company’s net income by the total value of its assets. It is usually calculated as a percentage. The standard formula for measuring ROA is as follows:
Return on Assets = (Net Income ÷ Total Assets) x 100
The net income represents the total earnings or profit of a company in a particular period of time. There are various ways to calculate the net income. For instance, if an investor wants to consider the ROA before the borrowing cost, they would add the expenses on interest to the net income.
Total Assets may include physical assets such as all the resources available in the successful conduct of business as well as investments in the company, and the money owed to a debtor. One can choose what to include in the total assets based on the nature of the analysis.
The size of the company’s asset base has a great impact on the resultant Return on Assets. Although not a rule of thumb by any means, the bigger the size of the company’s assets is, the lower the Return on Assets will be. This is generally, although not always, the case. Smaller companies have generally higher Return on Assets due to the denominator being significantly smaller than a large corporation.
Although some of the stockholders, investors, and analysts are more interested in calculating return on a particular investment rather than ROA, it’s still an effective assessment tool for the management. By calculating the Return on Assets, the management can assess the efficiency of utilization of available resources, and the money assigned to financial tasks.
A regular appraisal of the Return on Assets can help the analyst identify patterns in the use of assets in a given time period and find out trends. It also helps in the comparison of a company’s business practices with those of its competitors.
In addition to being a tool for ensuring accountability, the Return on Assets also helps the management determine whether to expand the company’s operation or to invest in improving the existing processes.