Return on Assets

This measures the company's profitability, expressed as a percentage of its total assets.

Why it is important

Return on assets (ROE) measures how effectively a company has used the total assets at its disposal to generate earnings. Because the ROA formula reflects total revenue, total cost, and assets deployed, the ratio itself reflects a management's ability to generate income during the course of a given period, usually a year.

The higher the return the better the profit performance. ROA is a convenient way of comparing a company's performance with that of its competitors, although the items on which the comparison is based may not always be identical.

ROA = net income / total asset

Variation of this formula

A variation of this formula can be used to calculate return on net asset (RONA)

RONA = net income/(fixed assets + working capital)

And, on occasion, the formula will separate after-tax interest expense from net income:

ROA = (net income + interest expense) / total assets

It is therefore important to understand what each components of the formula actually represents.

TRICKS OF THE TRADE

• Some experts recommend using the net income value at the end of the given period, and the assets value from beginning of the period or an average value taken over the complete period, rather than an end-of-the-period value; otherwise, the calculation will include assets that have accumulated during the year, which can be misleading.
  
  
• While a high ratio indicates a greater return, it must still be balanced against such factors as risk, sustainability, and reinvestment in the business through development costs. Some managements will sacrifice the long-term intersts of investors in order to achieve an impressive ROA in the short term.
  
  
• A climbing return on assets usually indicates a climbing stock price, because it tells investors that a management is skilled at generating profits from the resources that a business owns.
  
  
• Acceptable ROAs vary by sector. In banking, for example, a ROA of 1% or better is considered to be the standard benchmark of superior performance.
  
  
• ROA is an effective way of measuring the efficiency of manufacturers, but can be suspect when measuring service companies, or companies whose primary assets are people.
  
  
• Other variations of the ROA formula do exist.