Return on Assets (ROA)

Table of Contents

What is ROA?
What is the ROA Formula?
Advanced ROA Formula
Return on assets
ROA vs Return on Equity (ROE)
ROA – Higher or Lower?
How to Use ROA
Limitations of ROA
Frequently Asked Questions

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 =

$\frac{N e t I n c o m e}{T o t a l A s s e t s} \times 100$

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=

$\frac{N e t P r o f i t}{A v e r a g e A s s e t s} \times 100$

Return on assets

If company ABC has:

Net income = ₹2,00,00,000

Total Assets = ₹18,50,00,000

ROA =

$\frac{2, 00, 00, 000}{18, 50, 00, 000} \times 100$

= 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 = $\frac{N e t I n c o m e}{T o t a l A s s e t s} \times 100$

ROE = $\frac{N e t I n c o m e}{S h a r e h o l d e r E q u i t y} \times 100$

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

What is a good ROA ratio?

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.

What does negative ROA mean?

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.

Does ROA equal ROE?

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.

Which is better ROE or ROA?

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.

Why is ROE higher than ROA?

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.