Return on Assets (ROA) is a type of return on investment (ROI) metric that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit (net income) it’s generating to the capital it’s invested in assets. The higher the return, the more productive and efficient management is in utilizing economic resources.
What is the ROA Formula?
The ROA formula is:
ROA = Net Income / Average Assets
ROA = Net Income / End of Period Assets
Net Income is equal to net earnings or net income in the year (annual period)
Average Assets is equal to ending assets minus beginning assets divided by 2
What is the Importance of Return on Assets?
The ROA formula is an important ratio in analyzing a company’s profitability. The ratio is typically used when comparing a company’s performance between periods, or when comparing two different companies of similar size in the same industry. Note that it is very important to consider the scale of a business and the operations performed when comparing two different firms using ROA.
Typically, different industries have different ROA’s. Industries that are capital-intensive and require a high value of fixed assets for operations, will generally have a lower ROA, as their large asset base will increase the denominator of the formula. Naturally, a company with a large asset base can have a large ROA, if their income is high enough.
What is Net Income?
Net income is the net amount realized by a firm after deducting all the costs of doing business in a given period. It includes all interest paid on debt, income tax due to the government, and all operational and non-operational expenses.
Operational costs can include cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property. Also added into net income is the additional income arising from investments or those that are not directly resulting from primary operations, such as proceeds from the sale of equipment or fixed assets. Note: non-operating items may be adjusted out of net income by a financial analyst. Net income/loss is found at the bottom of the income statement and divided into total assets to arrive at ROA.