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Understanding ROA Formula

Introduction

Return on Assets (ROA) indicates the percentage of profitability of a company’s assets in terms of revenue generation.

The ROA can be calculated as follows:

The phrase Return on Average Assets (ROAA) is also used to emphasize that average assets are used in the formula above.

ROA is calculated by sharing a company’s net income by its average total assets. It is then expressed as a percentage. Net income is at the bottom of a company’s income statement, along with help on the balance sheet.

What is Return on Investment (ROA)?

Return on investment is an indicator of profitability that indicates the profit that a company can generate from its assets. In other words, the return on assets (ROA) measures the effectiveness of a company’s management in making profitable its economic resources or its assets on the balance sheet.

ROA is displayed as a percentage. The higher the number, the more effectively a company’s management manages its balance sheet to generate profits.

Calculation of return on investment (ROA)

Average total assets are used in the calculation of ROA because a company’s total assets may vary over time due to the procurement or sale of vehicles, land, or equipment, as well as changes in inventory or seasonal fluctuations in sales. This makes the calculation of average total assets for the period in question more accurate than the calculation of total assets for a period. The total assets of a business can be found on the balance sheet.

Example of return on assets (ROA)

Exxon Mobil Corporation (XOM)

Below is Exxon’s 10K Bill Balance Sheet showing total assets for 2021 and 2020.2 Note the differences between the two and how it affects ROA

Below is Exxon’s 2021 Bill 10K income statement:

Exxon’s ROA is more significant than other companies in the same industry.

What is the Importance of Return on Assets?

The ROA formula is an essential ratio in analyzing a company’s profitability. The balance is typically used when comparing a company’s performance between periods or 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 firms using ROA.

Typically, different industries have different ROAs. Capital-intensive sectors that require a high value of fixed assets for operations will generally have a lower ROA, as their large advantage base will increase the denominator of the formula. A company with a large asset base can have a large ROA if its income is high enough.

What is Net Income?

Net income is the net amount a firm realizes after deducting all the business costs 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 the cost of goods sold (COGS), production overhead, administrative and marketing expenses, and amortization and depreciation of equipment and property.

Also added to net income is the additional income arising from investments or those not directly resulting from primary operations, such as proceeds from the sale of equipment or fixed assets.

Net income/loss is found at the bottom of the income statement and divided into total assets to arrive at ROA.

Video example of return on investment in financial analysis

ROA is commonly used by analysts who conduct economic studies of a company’s performance.

ROA is important because it makes companies easier to compare. Imagine two companies…one with a net income of $50 million and assets of $500 million, the other with a net income of $10 million and assets of $15 million.

What are the disadvantages of ROA as a performance metric?

The disadvantages of ROA are:

  • ROA does not use forward-looking statements.
  • ROA displays historical information and is a retrospective measurement.
  • The ROA does not provide an answer to the question of why the ROA has increased or decreased.
  • ROAs vary significantly from company to company within the same industry, so ROAs are not comparable unless they relate to the same type of company.

The essential

Because ROA shows how efficiently a company uses its assets to generate profits so that it can be used for comparison purposes within the same industry.

The ROA can also be used to predict future returns.

The ROA is important, but it has limitations, e.g., B. And also Not including the use of debt.

ROA Formula should be used in unification with other financial metrics such as ROE and profit margin to better indicate performance efficiency.

Frequently Asked Questions About The Return On Assets (ROA)

What does ROA mean?

ROA stands for Return on Assets.

What is ROA?

Return on Assets (ROA) is a metric that measures how professionally a company can generate profits with its assets.

How to calculate the ROA?

Return on investment is calculated by dividing a company’s net income by its total assets.

Why do investors care about ROA?

ROA Formula is beneficial for comparing two companies in the same industry. It is because the assets required to do business in different industries can vary widely, making it difficult to appropriately compare an airline and a law firm, for example.

What does a higher ROA metric mean?

Stated as a percentage, a higher ROA indicates a more efficient use of company resources.

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