Return on Assets is a metric to measure the business profit in relation to its total assets. It indicates how well a company uses its assets (capital) to generate profit (net income). If your returns are higher, it means your business is efficiently utilizing its assets. If not, it implies that your business is not performing well.
Read on to find what is ROA, how to calculate it, and how to use it?
Understanding Return on Assets (ROA):
Return on Assets is a profitability ratio that compares the value of assets to the rate of return (profit) it makes within a specific time.
Suppose a company owns different tools, plants, and machinery for manufacturing footwear. Besides, it also keeps the stock to sell for the future. These are business assets. The money the company gets by selling the footwear after deducting the expenses is its profit. Both the assets and expenses incurred on it are used for calculating ROA.
ROA is useful for your business as it provides information to the management and investors that how a company is utilizing its financial resources to get profit. It is similar to other ways of measurement like return on investment (ROA) and return on equity (ROE) to predict a company’s success.
How to Calculate ROA?
The basic formula to calculate ROA is too simple. You just need to divide net profit or income with the average assets. To represent ROA in the percentage, you should divide net income with the total asset. Then, you should multiply the result by 100.
Here are the basic formulas to calculate ROA:
ROA = Net Profit / Average Assets
ROA = (Net Income / Total Assets) x 100
You can find out net profit from the income statement. In addition, you can get the value of the assets by the monthly, quarterly, or annual balance sheet. These details can be found in the company’s annual or quarter earning reports.
How to use ROA?
ROA is helpful for predicting the company’s performance as when it raises, it means your company is earning more profit on each pound it spends on assets. On the contrary, a decline in ROA suggests that a company is performing poorly or there are too many expenses and it’s going to cause trouble in the future.
You need to be careful while comparing the ROAs of different companies. As if companies are of different sizes or industries, the ROA might not work there. Similarly, ROA may also for the companies having the same industry and size but are in different stages of the business cycle.
Quick Sum Up:
Generally, if you’re getting a 5% ROA, it means you are getting a good ratio. Besides, if your company’s ROA is 20%, it is considered great. However, while comparing the return on assets with another company, you need to make sure that your competitor is in the same industry and has the same size as yours.
Though the return on assets is a helpful calculation, it is not the only way to measure the company’s financial health. It needs to be used with other metrics like ROI and ROE to get better results.
You can get the help of our accountant to calculate your ROA. Contact us anytime!
Disclaimer: This blog provides general information on ROA.