Return on net assets
Return on net assets is a measure of profit attributable to total assets. It talks about the company's ability to generate profits and the effectiveness of managing its assets. The higher the ratio, the better for the company because the financial situation of the company is better. It informs about the company's ability to generate profits and the effectiveness of managing its resources. ROA is also an important indicator for institutions granting loans ^{[1]}.
ROA = net profit / total activity x 100%
Description of the indicator Return On Net Assets
Return On Net Assets indicates the ability of a company to generate a net profit from its assets (total capital). High values of the indicator indicate high profitability of total assets. It should be remembered, however, that high values of the ratio may be caused by the age of the fixed assets involved, which, although depreciated to a large extent, did not lose production Capacity. Therefore, the degree of wear and tear of fixed assets should be additionally taken into account in the assessment and, if it is high, it should be taken into account in the interpretation. ROA is very similar to ROE. The difference lies in the fact that in ROE we check how well for example each dollar belonging to a company (not indebted) can earn, while ROA measures how well each dollar invested in a company can earn (regardless of whether it is indebted or comes from a loan). ROA (if positive) is smaller than ROE because 'assets are always larger than equity. High values of the total assets profitability ratio and the increase in its level over time are assessed positively (it proves high or increasing profitability of total assets). We consider the low value of the ratio and the decrease in its level in time as negative (it indicates low or decreasing profitability of total assets). Of course, the best value for ROA is several dozen per cent. However, one should be careful, as very high profitability is usually difficult to maintain for a long time and often more valued is 10% maintained for several years than a one-time jump on 30%. Therefore, it is always worth noting the historical ROA chart and comparing it with ROA for the industry and the broad market ^{[2]}.
Application of Return On Net Assets
Indicative analysis is one of the segments of the general financial analysis of the company. It deals with the study of the state and development of the company's finances, i.e. it provides information about the financial condition of the company ^{[3]}. Running your own business, which will achieve profits, would be very difficult without the analysis of factors and events occurring in the organization - affecting the obtained financial results. For example, the fact that a company generates income of US$5 000 does not provide us with relevant information without knowing the amount of income in a given period and the value of assets and equity ^{[4]}. Based on the results of this analysis, managers can properly direct the activities of an economic entity and identify areas of improper management that may harm the functioning of the company in the future.
As the name suggests, index-based analysis is based on a set of specific indicators. They provide a picture of the links and relationships between the figures in the financial statements ^{[5]}. In this case, the main sources of information are the balance sheet and the profit and loss account ^{[6]}.
According to both theoreticians and accounting practitioners, these two elements of the financial statements contain the most relevant information needed to analyse the financial position of a company. Profitability indicators are very often considered to be the most important element in analysing the financial and asset situation of a company. Not only for business people but also individuals and businesses in the immediate environment (e.g. contractors, customers, suppliers, banking institutions, etc.).
The basis for determining profitability are the ratios showing the relationship between the two:
- the amount of profit generated by the company and
- the value of the factor whose profitability we intend to determine.
From a mathematical point of view, profitability is presented as the quotient of net profit to the appropriate value of a specific financial component - expressed as a percentage. The return on assets can be developed to examine the financial performance of both groups of assets separately:
- Return on fixed assets:
ROA = net profit / fixed assets X 100%
- Return on current assets:
ROA = net profit / current assets X 100%
In summary, the return on total assets ratio is used in the business to examine the quality and efficiency of the company's management. The two other indicators, which are an extension of the ratio, help to assess the level and proper debt service ^{[7]}.
Examples of Return on net assets
- Return on net assets (RONA) measures the extent to which a company is able to generate profits from its total assets. This is calculated by dividing the company’s net income by its total assets. A higher return on net assets ratio indicates that a company is more efficient at generating profits from its assets. For example, if a company has a net income of $100 and total assets of $500, its return on net assets would be 20%.
- Another example of return on net assets is when a company has a net income of $1,000 and total assets of $2,000. In this case, the return on net assets would be 50%. This indicates that the company is generating more profits from its assets than the first example.
- A third example of return on net assets is when a company has a net income of $2,000 and total assets of $4,000. In this case, the return on net assets would be 50%. This indicates that the company is generating the same amount of profits from its assets as the previous two examples.
Advantages of Return on net assets
Return on net assets is an important financial metric used by investors and analysts to measure the profitability of a company. It provides an indication of the company’s ability to generate profits from its assets. The following are some of the advantages of using return on net assets:
- It is a simple and easy to understand metric that can be easily calculated from a company’s financial statements.
- It can be used to compare the efficiency of different companies in managing their assets.
- It helps investors and analysts to identify potential opportunities for improvement in a company’s asset utilization.
- It is useful for understanding the short-term and long-term performance of a company.
- It provides insight into the effectiveness of the company’s capital structure and its ability to finance its operations.
Limitations of Return on net assets
Return on net assets is a measure of profitability that indicates how effectively a company is using its assets to generate profits. However, there are several limitations associated with this measure. These include:
- It does not take into account the quality of the assets or their liquidity. It also does not take into account the cost of borrowing money or the cost of capital.
- It does not consider the size of the company when analyzing its performance.
- It does not consider the company's debt burden or its ability to service that debt.
- It does not account for the depreciation of assets or the effect of inflation on the value of those assets.
- It does not measure the risk associated with the investments the company has made.
- It does not take into account the tax implications of the company's investments.
Return on net assets is a measure of profit attributable to total assets. It talks about the companys ability to generate profits and the effectiveness of managing its assets. Other approaches related to return on net assets include:
- Return on Equity: This measure looks at the profitability of the shareholders’ investments. It is calculated by dividing the company’s net income by the total value of shareholders' equity.
- Return on Assets: This approach looks at the effectiveness of a company’s assets. It is calculated by dividing the company’s net income by the total value of its assets.
- Debt-to-Equity Ratio: This metric looks at a company’s ability to finance its operations with debt and equity. It is calculated by dividing the company’s total debt by the total value of its shareholders' equity.
- Asset Turnover Ratio: This approach looks at the efficiency of a company’s assets. It is calculated by dividing the company’s total sales by the total value of its assets.
In conclusion, return on net assets is a key measure of the company's profitability and efficiency, and there are a number of other metrics related to it that can give investors and managers insight into the financial health of the business.
Footnotes
Return on net assets — recommended articles |
Bank efficiency ratio — Return on sales — Du Pont analysis — Asset equity ratio — Market value added — Accounting ratios — Capitalization ratios — Combined Ratio — Cost-income ratio |
References
- Heikal M., Mhaddafi. K., Ummah A. (2014), Influence Analysis of Return on Assets (ROA), Return on Equity (ROE), Net Profit Margin (NPM), Debt To Equity Ratio (DER), and current ratio (CR), Against Corporate Profit Growth In Automotive In Indonesia Stock Exchange, "International Journal of Academic Research in Business and Social Sciences", Vol. 4, No. 12, pp 121-123
- Jewell J., Mankin J. A. (2012), What is Your ROA? An Investigation of the Many Formulas for Calculating Return on Assets, "Academy of Educational Leadership Journal", Vol. 15, pp. 2-3
- Majed A. (2012), The Relationship between the ROA, ROE and ROI Ratios with Jordanian Insurance Public Companies Market Share Prices, "International Journal of Humanities and Social Science" 2(11), pp. 115-120
- Warrad L. (2015), Return on Asset and Return on Equity Effects of Net Operating Cycle: Jordanian Study, "Research Journal of Finance and Accounting", 6(14), pp. 89
- Zamfir M. M., Manea D., Ionescu L. (2016), Return On Investment - Indicator for Measuring the Profitability of Invested Capital, "Valahian Journal of Economic Studies", Vol. 0 (0), pp. 98-101
Author: Aleksandra Morzywołek