Sitemap

Return on assets definition

Description

This is a very popular and, again, a very simple ratio, which reflects a relationship between company’s income and the assets, used to generate it. Data to calculate this ratio is collected from the balance sheet (assets) and income statement (income). ROA is a key indicator which is used to evaluate how profitable a company in relationship with its total assets.

ROA is an important ratio for company’s owners, investors and creditors, as it is one of the most general ratios that shows how efficiently the asset is being managed. Return on asset indicates how much net income is generated per one dollar of assets. However, analyzing company’s profitability relying only on ROA would not be recommended, it is a must to calculate other profitability ratios, too. Sometimes different ROA calculations can be used. This is because some investment analysts use the EBIT figure instead of the net income.

Norms and limitations

In most cases the owners and investors find ROA value of less than 5% not acceptable. However, for banks that are interested only in safety of their credits, a value of ROA as low as 1.5% is rather reasonable.

ROA is very dependent on the industry that the company is operating in. In such industries as shipbuilding industry, return on asset ratio is usually low. On the other hand, in industries like software industry the same ratio is significantly higher. So it is not reasonable to compare a value of ROA between companies from different industries.

Formula

Assets (Total assets) – mean every asset that the company owns and that is shown on the balance sheet. Total assets equals total liabilities + owner’s equity.

Net income (net profit, net earnings), usually called “the bottom line”, is a measure which is calculated by taking revenues (sales and other incomes) and adjusting them to the cost of sales, operating cost, depreciation and amortization, interest, taxes and other expenses.