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Return On Assets (ROA): Key Takeaways

Return on assets (ROA): Key Takeaways

DEFINITION:

Return on assets (ROA, in Finnish kokonaispääoman tuottoprosentti, koko pääoman tuottoaste) is a metric that measures the profitability of a business in relation to its overall assets; assesses how efficient a company is in using its assets to generate revenues. The financial ratio measures:

  • the rate of return on the total assets (where total assets are equal to the sum of the company's liabilities and shareholders' equity);
  • a firm's efficiency at generating profits from shareholders' equity plus its liabilities;
  • how well a company uses what it has to generate earnings.

FORMULAS for calculations:

Ratio is expressed as a percentage.

\[ {ROA} = {Net\ Income \over Total\ Assets} * 100 % \] \[ {ROA} = {Net\ Income \over Revenue} * {Revenue \over Total\ Assets} = {Net\ Margin * Total\ Asset\ Turnover}\]

RESULT INTERPRETATION:

  • Can vary across industries.
  • Should be used to compare companies within the same industries.
  • The scale of a business and the operations performed should be considered when comparing the ROA of two different firms.
  • It is important to look at this financial ratio from a long-term perspective; i.e., compare a company against its own previous ROA numbers.
  • The higher the ROA the better, as it indicates more asset efficiency.
  • BUT, according to Warren Buffett, the really high ROA % may indicate vulnerability in the durability of the competitive advantage.
  • Improving ROA is a good sign, as it means the company is able to exploit its assets better and management is efficient in managing the available resources.
  • ROA higher than 5% are generally considered good and over 20% excellent.
  • A low ROA indicates that the company's management is not able to use efficiently its assets for getting more profits; this is a sign the company may have trouble.
  • Negative ROA is caused by negative earnings:

    - this is typical situation for young companies in an early stage of their corporate life cycle, thus, they can be unprofitable at first.

    - this is a sign that the company is not able to acquire and utilize its assets sufficiently enough to generate a profit; it may indicate the financial distress within a company.

  • Note: some companies may keep over or under valuing its assets to reduce taxation, thus, they can manipulate the data. In such a case, the ROE result will not reflect the real situation in the company.

EXAMPLE:

A company's ROA is equal to 20 %:

This means that every euro that the company invested in assets during the year produced 20 cents of net profit.

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