Return on Assets = Net Income / Average Total Assets
Business owners, operators, and investors will look to ROA as a measure of the company’s financial health and profitability. Companies want a higher ROA value, which means they are making better use of their assets.
Return on asset is net income divided by total assets.
Asset balances change daily due to the purchase of equipment, the sale of equipment, inventory changes, and seasonal sales fluctuations. That’s why we must calculate average assets over the accounting period.
Remember that the time period for the numerator and denominator must match. For example, to calculate ROA for the fiscal year 2021, you would use annual net income and the average assets across the year.
ROA is also related to a company’s profit margin multiplied by its asset turnover. As you can imagine, the ROA formula takes into account profitability (via the numerator) and asset utilization (via the denominator).
We will explore the return on assets calculation further in the next section.
To calculate return on assets, you will need to know the net income and the average total assets for the accounting period. If you are given these two values, you can use the simplest form of the formula:
ROA = Net Income / Average Total Assets
If you are given starting and ending assets, then you will need to calculate the average first then enter that value as the denominator.
If you are given an income statement without the bottom line, then you will need to calculate net income first. As a reminder, this value may also be called net profit or net earnings.
ROA is always displayed as a percentage. Companies that operate with a net loss would have a negative ROA. All things considered, a business would want a higher ROA.
In this next section, we will walk through several return on assets examples.
Now let’s calculate return on asset using the example of Company A over two years, 2021 and 2022.
Company A, FY2021
Company A, FY2022
Here is the math for 2021:
Average Assets = (Starting Assets + Ending Assets) / 2
Average Assets = ($600,000 + $580,000) / 2
Average Assets = $590,000
ROA = Net Income / Average Assets
ROA = $230,000 / $590,000
ROA = 38.98%
Since we are given the average for 2022, we can skip that step. And here is the math for 2022:
ROA = Net Income / Average Assets
ROA = $250,000 / $800,000
ROA = 31.25%
As you can see, Company A grew revenue by 25% and profit by 9% in 2022. That said, ROA decreased from 2021 to 2022 because assets grew faster than profit.
In addition to calculating return on assets, there are other income ratios that help people understand the financial health of a business.
Profit margin generally refers to net profit margin. Here is the net profit margin formula:
Net Profit Margin = Net Profit / Revenue
That said, you could also generate a profit margin from gross profit or operating profit.
The asset turnover ratio formula is:
Asset Turnover Ratio = Revenue / Average Total Assets
Companies will want a higher asset turnover ratio because that shows they are using their assets efficiently.
This is a measure of efficiency, as it is better for a business to generate more profit with less equity investment.
The return on equity formula is:
ROE = Net Profit / Average Shareholders’ Equity
ROE is expressed as a percent. The higher the number, the more efficient the company is at generating profit.
A business can improve its net income by increasing revenue, decreasing expenses, decreasing interest payments, decreasing taxes, decreasing depreciation, and decreasing amortization.
Companies with high intangible asset balances may not find the return on total assets to be a useful metric. Instead, analysts might choose to look at return on fixed assets.
For instance, a software company, a hardware company that uses an outsourced manufacturer, and an energy company would have vastly different asset bases. Using ROA would not be appropriate to compare their financial health, risk, or profitability.
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