Return on assets (ROA)

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Return on assets (ROA)
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Return on assets (ROA) is a measure of financial performance calculated by dividing net income by total assets. It is used to measure how effectively a company can use its assets to generate profits. By comparing ROA over time, analysts can assess a company's financial performance.

ROA is a useful metric for evaluating a company's overall performance, as it measures how effectively a company can use its assets to generate profits. It is also useful for comparing a company with its peers, as it allows analysts to assess the financial performance of a company relative to its competitors. Moreover, by comparing ROA over time, analysts can assess trends in the company's financial performance and make more informed decisions.

Example and Formula of Return on assets (ROA)

To illustrate the concept of Return on Assets (ROA), consider the following example:

Let's assume Company A has net income of $1 million and total assets of $10 million. The ROA for Company A would be calculated as follows:

In this example, Company A has an ROA of 10%, which indicates that it is able to generate $0.10 in profits for every dollar of assets. This indicates that the company is able to effectively use its assets to generate profits.

The formula for return on assets (ROA) is calculated by dividing a company's net income by its total assets. This allows analysts to measure and compare a company's financial performance to its peers, as well as identify and monitor trends in the company's financial performance over time. By doing so, analysts can gain insight into the company's overall performance and make more informed decisions.

When to use Return on assets (ROA)

  • To assess a company's overall financial performance: ROA is a useful metric for evaluating a company's overall performance, as it measures how effectively a company can use its assets to generate profits.
  • To compare a company with its peers: ROA is also useful for comparing a company with its peers, as it allows analysts to assess the financial performance of a company relative to its competitors.
  • To assess trends in the company's financial performance: Analysts can also use ROA to assess trends in the company's financial performance by comparing ROA over time, which can help them make more informed decisions.

Types of Return on assets (ROA)

  • Operating ROA: Operating ROA measures how effective a company is at generating income from its core operations. It is calculated by dividing the company's operating income by its total assets.
  • Financial ROA: Financial ROA measures the efficiency of a company at generating income from its financing activities. It is calculated by dividing the company's financing income by its total assets.
  • Economic ROA: Economic ROA measures the overall efficiency of a company at generating income. It is calculated by dividing the company's economic income by its total assets.

Steps of Return on assets (ROA)

  • Calculate Net Income: The first step in calculating ROA is to calculate the net income of a company. This is calculated by subtracting all expenses from total revenues.
  • Calculate Total Assets: The second step in calculating ROA is to calculate total assets. This is calculated by adding all assets, such as cash, inventory, property, and equipment.
  • Calculate ROA: The third step is to calculate the ROA by dividing net income by total assets. This ratio indicates how efficiently a company can use its assets to generate profits.

Advantages of Return on assets (ROA)

  • Increased Profitability: By measuring the company's ability to generate profits from its assets, ROA provides insight into the company's overall profitability.
  • Comparative Analysis: ROA is useful for comparing a company with its peers, as it allows analysts to assess the financial performance of a company relative to its competitors.
  • Historical Analysis: Analysts can also use ROA to identify trends in the company's financial performance over time. This can be useful when making decisions about the future of the business.

Limitations of Return on assets (ROA)

Despite its advantages, ROA has certain limitations that should be taken into consideration when evaluating a company's financial performance. These include:

  • ROA does not take into account the company's debt or off-balance sheet liabilities. As such, it may not accurately reflect a company's true financial performance.
  • ROA can be distorted by non-recurring expenses and one-time gains.
  • ROA does not provide any insight into the sustainability of a company's profits.

Other approaches related to Return on assets (ROA)

  • Return on Equity (ROE): Return on Equity is a measure of financial performance that calculates the net income of a company divided by its shareholders' equity. It is used to measure how efficiently a company can use its shareholders' equity to generate profits. By comparing ROE over time, analysts can assess a company's financial performance and make more informed decisions.
  • Economic Value Added (EVA): Economic Value Added (EVA) is a measure of financial performance that calculates the net income of a company minus its cost of capital. It is used to measure how efficiently a company can use its resources to generate profits. By comparing EVA over time, analysts can assess a company's financial performance and make more informed decisions.

These measures are related to ROA as they all measure the effectiveness of a company in generating profits. ROE, for example, measures the efficiency of a company in using its shareholders' equity to generate profits, while EVA measures the efficiency of a company in using its resources to generate profits. Analysts can use these measures to assess a company's financial performance and make more informed decisions.

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