Return on Assets (ROA)
Table of Contents
What is ROA?
Return on Assets (ROA) is a profitability ratio that indicates a company’s profitability in relation to its total assets. ROA is used by corporations to determine that resources are being used to generate profits. It is calculated through a formula and is shown as a percentage. The higher the percentage, the more the company makes use of its assets optimally to gain resources.
What is the ROA Formula?
To calculate the ROA of a company, all one needs is information about the company’s net income and total assets. One can find out a company’s ROA simply by dividing its net income by its total assets. The result is then multiplied by 100 to find the percentage of ROA.
ROA =
Net IncomeTotal Assets × 100Net IncomeTotal Assets × 100
Advanced ROA Formula
There is no certainty that the assets and expenditure of a company stay the same. To consider these changes and to further strengthen the ratio of ROA, an advanced ROA formula was designed. This advanced ROA formula considers the changing assets of the company over time and thus yields appropriate results.
ROA=
Net ProfitAverage Assets × 100Net ProfitAverage Assets × 100
Return on assets
If company ABC has:
Net income = ₹2,00,00,000
Total Assets = ₹18,50,00,000
ROA =
2,00,00,00018,50,00,000 × 1002,00,00,00018,50,00,000 × 100
= 10.8%
Therefore, the return on assets of the company will be 10.8%.
ROA vs Return on Equity (ROE)
While both ROA and ROE are used to measure how efficient a company is at generating profits, there are significant differences between the two. ROA takes leverage or debt into account but ROE does not. ROE uses net income and divides it by shareholder equity. There are differences between their formulas as well.
ROA = Net IncomeTotal Assets × 100Net IncomeTotal Assets × 100
ROE = Net IncomeShareholder Equity × 100Net IncomeShareholder Equity × 100
Thus, ROE is the net income divided by shareholder equity whereas ROA is the net income divided by total assets. The result is then multiplied by 100 in both cases to determine the final percentage.
ROA – Higher or Lower?
ROA should definitely be higher. This is because a higher ROA shows that the company is able to gain more profits even with a low investment. It shows more asset efficiency. However, a lower ROA can be a problem. A low ROA isn’t a good sign as it indicates that the company isn’t able to use its assets optimally to gain profits.
How to Use ROA
ROA can be used by management, analysts, and investors to determine if their company or the company they are interested in uses its assets optimally to generate profits.
Limitations of ROA
While there are many benefits of ROA, there are many limitations.
- One cannot use ROA across industries. This is because the expenditure, net income, technology used, assets, etc., of every industry, are different.
- Many companies make use of different types of formulae to calculate ROA. This can show discrepancies.
- The net profit figure is open to manipulation by the management.
Frequently Asked Questions
The higher the ROA of a company, the higher its profit generation. A good ROA can be anywhere between 5% and 20%. A 5% ROA is considered to be good, and a 20% ROA is considered to be excellent. However, this ratio should be determined across companies belonging to the same sector.
When there are costs that outweigh revenues, a negative ROA is seen. A company can also have a negative ROA which means that the company is not able to acquire or use its assets optimally enough to generate a profitable return. A negative ROA is possible if ROA makes use of net income as its denominator. Any negative number will eventually lead to a negative ROA.
The key difference between ROE and ROA is that ROA takes into account the debt or leverage of a company. Besides this, the two are simple measures of how efficient a company is in generating profits. In case a company has no debt or leverage, ROA and ROE will come out equal. So, yes, there can be instances where ROA equals ROE.
While both are measures of a company’s profitability, there are significant differences between the two. However, it is not always clear as to which is better. While ROA can tell you if the company is using its assets well, ROE can show the success of the company’s equity management.
A company can have a low ROA even if it has a high ROE. This indicates that while the company is successful in managing its equity, it is not as successful in managing its assets. This could be because ROA considers debt. Therefore, it is better to keep the two separate and use ROA when debts are to be considered and use ROE when there is a question of equity management.
ROE is the net income divided by shareholder equity whereas ROA is the net income divided by total assets. In most cases, ROE is higher than ROA as ROA considers the debts or leverages of the company whereas ROE does not. It is common that a company takes on financial leverage which will result in a higher ROE than ROA. There can also be times when the two come out equal. This happens when the company has not acquired any debt or leverage.
Most Popular Terms
Read the Latest Market Journal
2023: What you need to know about Market Volatility & Your Investments
The S&P 500 finished 2022 with a 18.1% loss, marking the 7th worst loss since...
Introduction to Global Recycling Day Did you know that the Global Recycling Day falls on...
Top traded counters in February 2023
Start trading on POEMS! Open a free account here! Events to note – At a...
How to identify and trade a downtrend
Introduction When the stock markets take a dip, investors tend to panic sell. However, there...
Top traded counter in January 2023
Start trading on POEMS! Open a free account here! At a glance: The “January effect”...
Intuitive Surgical, Inc (NASDAQ:ISRG): Leading Healthcare Stock to Look out for
On 1 Feb 2023, the Federal Reserve raised interest rates by 0.25%, bumping the federal...
Key Events in 2023 to Look Out For
In 2022, the Russia-Ukraine war caused prices to spiral globally, causing inflation in the US...
Should You Consider Index Investing?
There has always been a debate in the investing community about whether active or passive...
