What Is Return On Assets (ROA)?
Return on assets (ROA) is an important measurement of a company's profitability. Usually stated as a percentage, ROA measures net income divided by the company's total assets.
Derived from the company's balance sheet, assets include cash and cash-equivalent items, receivables, inventories, land, and buildings and equipment. They also include intangible assets such as intellectual property, copyrights and patents, the estimated value of brand and trade names, and goodwill.
Essentially, ROA shows how well a company is utilising its assets to generate profits. In other words, it shows the amount of money earned per dollar of assets. For example, a company with an ROA of 10% means it earned 10 cents for each US$1 in assets. Therefore, the higher the return, the more productive, efficient and profitable the company is, as the company is earning more money with less investment.
ROA vs ROE
Importantly, ROA differs from return on equity (ROE), which excludes debt. Assets, by contrast, includes liabilities plus shareholder's equity, as shown on the company's balance sheet.
As with ROE, investors and analysts should use ROA to compare a company's performance from one period to another. Likewise, ROA is only useful for comparing similar-sized companies in the same industry, as companies in different businesses have very different asset structures. It's also more relevant for asset-intensive businesses.
For example, companies in capital-intensive businesses, such as manufacturers and utilities, have a lot of physical assets, such as factories and equipment. On the other hand, service firms such as marketing agencies and software companies are more heavily invested in intellectual capital and have fewer assets. Generally speaking, the more assets a company has, the lower the ROA.
The U.S. banking industry, for example, has historically had an ROA in the 1.2% to 1.3% range over the past 30 years or so. During the depths of the global financial crisis in 2009, however, the ratio dipped below zero for a short time. It remained below 1% until 2013, when the industry started to recover.
ROA vs ROAA
ROA can be calculated two ways. The simplest way is to take a company's net income from its income statement and divide that by its total assets at the end of that period, such as a fiscal quarter or year.
Another way is to calculate the company's return on average assets (ROAA), in which net income is divided by the average of the company's assets at the beginning and end of the period being analysed. That method takes into consideration the changes in assets, such as from the sale or purchase or growth of assets by the company during the period.
Example Of An ROAA Calculation
For example, Anytown Bank earned US$1 million in 2018 and had US$100 million of assets at the end of the year, for an ROA of 1.0%. However, during the year it increased its asset base from $50 million the previous year. An average of the two equals US$75 million. Therefore, its return on average assets for 2018 would be 1.75%.
Return on assets (ROA) is a financial ratio that measures a company's net income divided by its assets, including debt, to determine how well it utilises its assets to earn a profit. It differs from return on equity (ROE), which excludes debt from the equation.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…