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Return on assets
Quick definition
Copy link to sectionReturn on Assets (ROA) is the amount of money a company earns or the profit it generates from the assets it has invested.
Key details
Copy link to section- A company’s return on assets tells you how well it uses what it owns to make more money
- A high ROA indicates effective management of resources
- Investors use this metric to judge whether a company can be trusted to spend its money wisely
What is the return on assets?
Copy link to sectionReturn on Assets is used by a company to determine how effectively it has used its assets to generate revenue. When the ROA is high, then the management of a company can safely conclude that they are employing efficiency in utilising the capital invested in the assets to generate income. Every company wants to have its capital utilisation optimised for high returns.
A company can use Return on Assets to determine its performance compared to other companies in the same industry. It can also compare its performance from one period to another to gauge its consistency and improvement.
Investors look into a company’s ROA and determine the success of the company in managing its assets to generate revenue. They are able to determine if a company is a good investment or otherwise, by comparing its ROA to other companies in the same industry. This is especially important when a company issues shares for potential investment.
Illustrations of Return on Assets
Copy link to sectionIllustration one
Copy link to sectionCompany A has $20,000 in total assets and a net income of $4,000 generated.
Return on Assets (ROA) = Total Income / Total Assets
So the company’s ROA = $4000 / $20000
ROA = 0.2 or 20%
This means that Company A’s Return on Assets is good. Asset efficiency is high.
Illustration two
Copy link to sectionCompany B has a net income value of $7,000 and assets valued at $100,000 at the beginning of the year. In the course of the year, it diversifies operations and closes the year with assets valued at $180,000.
The ROA here is calculated by first determining the average of the total assets since the asset value at the beginning of the year differs from the asset value at the end of the year.
Average Total Assets = (Assets at the beginning of the year + Assets at the end of the year) / 2
So in this case the Average Total Assets = ($100,000 + $180,000) / 2
Average Total Assets = $140,000
We can then use this number to calculate the company’s Return on Assets across the year. Return on Assets (ROA) is calculated as:
Return on Assets (ROA) = Total Income / Total Assets
So in this case the ROA = 7,000 / 140,000
Return On Assets = 0.05 or 5%
This means that Company B’s Return on Assets is good, though it could be improved.
In conclusion, Return on Assets gives shareholders a general view of the company’s efficiency in using its assets to generate profit.