Return on assets (ROA) is a metric for determining, measuring, and calculating a company’s profitability in terms of total assets. This ratio compares a company’s profit (net income) to the capital it has invested in assets to determine how well it is performing. The higher the return, the more productive and effective management is when it comes to utilizing financial resources.
Return on Assets Formula
You should first compute the company’s net income, which is equal to annual net earnings plus average assets (or end-of-period assets). The ROA formula is:
ROA = Net Income / Total Assets
The Return on Assets Ratio and Its Application to Investors
ROA calculation can help investors in a variety of ways. Here are some examples of how traders and businesses might benefit from it:
To determine the efficiency and profitability of a firm. It’s the chief factor to use ROA, especially if you’re seeking low-risk, long-term investment options.
To compare and contrast two companies. A fantastic opportunity to choose the best variant from the two investment options. However, instead of hiring cross-industry representatives, you should examine organizations that are similar in size and field.
To identify businesses that are asset-light or asset-intensive. If the ratio is low, the business belongs to the asset-intensive category (for example, airline company). When the ratio is high, a corporation is considered asset-light (for example, a software development company).
What’s Considered a Good ROA Percentage?
While the meaning of ROA varies considerably with industry, the metric itself provides useful information regarding a company’s asset efficiency. To put it another way, the majority of ROA percentages fit into one of three categories:
Excellent: When ROA broaches 20%, it’s considered an excellent use of assets.
Good: Companies with returns on assets higher than 10% offer a healthy outlook.
Bad: Negative ROA or a measure below 5% is alarming for investors.
Poor: ROA measuring 6-10% signals inefficiency in asset revenue generation.
Keep in mind that the best way to determine whether a Return on Assets is “excellent” is to compare it to competitors and similar businesses. The benchmarks listed above are broad, and their meaning varies based on the company or its business operations.
Why Return on Assets Is Important?
It’s a straightforward yet useful tool for investors to assess a company’s profitability. It allows you to compare and contrast business performance over a set period. ROA can be used to explore a single company or to compare two organizations over time to determine which is more efficient and productive.
While comparing two businesses, it’s a must that they’re the same size and operate in the same industry. The Return on Assets ratios in various fields is often different.
When comparing two distinct firms of varying sizes, the same thing applies, since some businesses use a larger quantity of assets and have a higher net income.
Advantage of ROA
The Return on Assets (ROA) % shows how successfully your company manages its balance sheet to create profits. Comparing your company’s ROA to that of other companies might help you figure out where you stand now and where you might go in the future. ROA helps in the enhancement of future business performance (e.g., increasing profits). It tells investors how well your company converts money into profit.
ROA is one of numerous profitability metrics investors use to contextualize a company’s financial performance, particularly asset-reliant enterprises. Asset efficiency is a useful metric for narrowing down various investments to the one that will best leverage assets to beat its rivals.