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Main Findings
Return on assets is a profitability ratio that measures how well a company can generate income from its total assets.
Return on assets shows how efficient a company's management is in using its economic resources to create value for its shareholders.
A higher ROA indicates a more productive and profitable company, while a lower ROA indicates a less productive and profitable company.
Return on assets (ROA) is a financial ratio that measures how profitable a company is to its total assets.
Total assets are the resources that a company owns and uses to generate income, such as cash, inventory, property, plant, and equipment. ROA indicates how efficiently a company uses its assets to produce net income, which is the amount of earnings left after deducting all expenses and taxes.
A higher ROA means that the company is more effective at converting its assets into profits, while a lower ROA means that the company is less productive and may have room for improvement.
Why is Return on Assets (ROA) important?
Return on assets (ROA) is important because it shows how well a company is managing its resources and generating value for its shareholders. ROA can be used by managers, analysts, and investors to evaluate a company's performance over time or to compare it with other companies in the same industry.
A high ROA indicates that the company can earn more money with less investment, which implies that it has a competitive advantage or a strong business model. A low ROA, on the other hand, suggests that the company may be wasting its assets or facing operational inefficiencies, which could hurt its profitability and growth potential.
Formula for Return on Assets (ROA)
The formula for return on assets (ROA) is:
ROA = Net Income / Average Total Assets
Net income is the amount of earnings that a company reports on its income statement for a given period. It is calculated by subtracting all expenses, taxes, and interest payments from the total revenue. Net income reflects the bottom line of a company's performance and represents the amount of money that is available to the owners or shareholders.
Average total assets is the average value of all the assets that a company owns and uses during a given period. It is calculated by adding the beginning and ending balances of total assets from the balance sheet and dividing by two. Average total assets smooth out any fluctuations in asset values that may occur during the period and provide a more accurate measure of the asset base.
How to calculate Return on Assets (ROA)
To calculate return on assets (ROA), follow these steps:
- Find the net income for the period from the income statement.
- Find the total assets at the beginning and end of the period from the balance sheet.
- Calculate the average total assets by adding the beginning and ending balances and dividing by two.
- Divide the net income by the average total assets and multiply by 100 to get the percentage.
For example, suppose a company has a net income of $50,000 for the year 2020. Its total assets at the beginning of 2020 were $500,000 and at the end of 2020 were $600,000. The average total assets for 2020 are:
Average Total Assets = ($500,000 + $600,000) / 2
Average Total Assets = $550,000
The return on assets for 2020 is:
ROA = ($50,000 / $550,000) x 100
ROA = 9.09%
This means that the company earned 9.09 cents of net income for every dollar of assets it invested in 2020.
Examples
To illustrate how to calculate the return on assets, let's look at some examples from different industries. We will use the ROA formula with the net income and average total assets for each company.
Exxon Mobil Corporation (XOM) is an oil and gas company that operates in a capital-intensive industry. According to its 10K statement for 2021, it had a net income of -$22,438 million and an average total asset of $311,016 million. Therefore, its ROA for 2021 was:
ROA = -$22,438 / $311,016 = -0.072 or -7.2%
This means that Exxon Mobil lost 7.2 cents for every dollar of assets it invested in.
Microsoft Corporation (MSFT) is a software company that operates in a less capital-intensive industry. According to its 10K statement for 2021, it had a net income of $61,271 million and an average total asset of $301,311 million. Therefore, its ROA for 2021 was:
ROA = $61,271 / $301,311 = 0.203 or 20.3%
This means that Microsoft earned 20.3 cents for every dollar of assets it invested in.
Starbucks Corporation (SBUX) is a coffee chain that operates in a moderately capital-intensive industry. According to its 10K statement for 2020, it had a net income of -$816 million and an average total asset of $24,223 million. Therefore, its ROA for 2020 was:
ROA = -$816 / $24,223 = -0.034 or -3.4%
This means that Starbucks lost 3.4 cents for every dollar of assets it invested in.
Limitations
While ROA is a useful indicator of a company's profitability and efficiency, it also has some limitations that should be considered when using it for analysis.
ROA can vary significantly across different industries depending on the nature and intensity of their operations. Therefore, it is more meaningful to compare ROA within the same industry or sector rather than across different ones.
ROA can be affected by the accounting methods used by a company to measure its net income and assets. For example, different depreciation methods can result in different values of net income and assets, which can affect the ROA calculation.
ROA does not account for the financial leverage or debt level of a company. A company with a high debt-to-equity ratio may have a higher ROA than a company with a low debt-to-equity ratio, but it also faces higher financial risk and interest expenses.
ROA does not reflect the growth potential or future performance of a company. A company with a low ROA may be investing heavily in research and development or expansion projects that will generate higher returns in the future, while a company with a high ROA may be reaching its peak or stagnating.
Conclusion
Return on assets is a profitability ratio that measures how well a company can generate income from its total assets. It shows how efficient a company's management is in using its economic resources to create value for its shareholders.
A higher ROA indicates a more productive and profitable company, while a lower ROA indicates a less productive and profitable company.
However, ROA should not be used in isolation or without considering the context and limitations of the ratio. It should be compared with other profitability ratios such as return on equity (ROE) or return on invested capital (ROIC), as well as with the industry average or benchmark. It should also be adjusted for the accounting methods and financial leverage of the company.
References
- Corporate Finance Institute. (n.d.). Return on Assets - ROA Formula, Calculation, and Examples. https://corporatefinanceinstitute.com/resources/accounting/return-on-assets-roa-formula/
- Investopedia. (2022). How to Calculate Return on Assets (ROA) With Examples. https://www.investopedia.com/ask/answers/031215/what-formula-calculating-return-assets-roa.asp
FAQ
ROA is a financial ratio that indicates the profitability of a company relative to its total assets. It shows how efficiently a company is using its assets to generate earnings.
ROA is calculated by dividing net income by total assets. The result is usually expressed as a percentage.
A high ROA indicates that the company is using its assets efficiently to generate profits. It’s a sign of good management and financial health.
While ROA can provide valuable insights, it’s most useful when comparing companies in the same industry. Different industries have different asset structures and profit margins, which can affect ROA.
ROA doesn’t account for the risks associated with the assets. Two companies may have the same ROA, but one may have riskier assets. Also, ROA can be manipulated by changes in accounting policies related to assets and income recognition.
