Return on Assets (ROA) : Meaning, Importance, Formula & Examples

What is Return on Assets?

Return on Asset, also referred to as ROA, is one of the fundamental financial ratios that is used by investors and other stakeholders to determine how profitable a company is for the total assets deployed. Users of this financial ratio include corporate management, analysts, investors, creditors, etc. who use the return on assets formula to determine how efficiently a company utilizes its assets to generate a profit. The ROA metric is also commonly expressed as a percentage by using the company’s two figures, namely net income and its average assets. The ROA metric gives investors and other stakeholders an idea of how effectively the company is able to convert the money it invests in the asset to net income. A higher ROA suggests that the company is more efficient and productive at managing its balance sheet to generate profits, whereas a lower ROA indicates that the company is not efficient at generating profit by deploying its assets and that there is room for improvement.

Geeky Takeaways:

• The return on assets metric indicates a company’s profitability in comparison to its total deployed assets.
• The return on assets is primarily used by management, analysts, investors, creditors, etc. to determine whether a company uses its assets efficiently to create profits.
• A company’s ROA can be calculated by dividing its net income by its total assets.
• A higher ROA denotes that the company is more efficient and productive at managing its assets to generate profits, and vice versa.

Importance of Return on Assets

1. Important Indicator: ROA is a very fundamental and important indicator for any company, as it shows investors how the company is actually performing in terms of converting assets into net capital.

2. Easy Comparison: ROA helps users compare the performance of companies with the same asset base over a period or make comparisons between companies that are of the same size and industry.

3. Determines Asset-Intensive Industries: A low ROA percentage of below 5% is an indication that a company is an asset-intensive company. This doesn’t primarily mean that a company is underperforming and not generating net profits. Certain companies, such as airlines, are naturally more asset-intensive than, for instance, software companies or service industries, which are asset-light businesses.

4. Decision-Making for Management: By taking the ROA indicator into account, managers are able to evaluate the internal results. This helps the management identify and correct potential deficiencies present in the company’s investment.

Calculating Return on Assets (ROA)

Formula:

In order to calculate the return on assets, the company is required to ascertain two major elements of finance, net profits and average assets/total assets.

• Net Profits: These are those profits from which all the operating and non-operating expenses are adjusted. This is also referred to as EBITDA in some cases.
• Average Assets/Total Assets: The company is required to ascertain the amount invested in the assets throughout the year. In case there is any addition or sale of assets, the opening and closing figures of the assets are to be added and divided by 2. This will bring out the average number of assets deployed during the year.

For instance, let’s compare three different sets of data:

Company	Net Income (₹)	Total Assets (₹)	ROA (%)
Alpha ltd.	25,00,000	50,00,000	50%
Beta ltd.	30,00,000	1,00,00,000	30%
Gamma ltd.	20,00,000	1,20,00,000	16.67%

Here, these figures suggest that for every ₹1 invested in assets, alpha, beta, and gamma have earned ₹0.50, ₹0.30, and ₹0.167, respectively. Alpha has shown the best figures among the three, and gamma has shown the lowest figures among the three.

Examples of ROA

Example 1:

From the given information of XYZ Ltd. calculate Return on Asset ratio.

• Net Income: ₹50,00,000
• Opening Assets: ₹1,00,00,000
• Closing Assets: ₹1,20,00,000

Solution:

(see working note-1)

ROA = 45%

Working Note-1: Calculation of Average Assets

Average Assets = ₹1,10,00,000

Example 2:

ABC Ltd. has ₹25,00,000 as its assets and gained a net income of ₹8,00,000 for FY23-24. Calculate the ROA for ABC Ltd.

Solution:

ROA= 8,00,000/25,00,000*100

ROA= 32%

This means that for every ₹1 invested in assets ABC Ltd. has generated ₹0.32 of net profit.

What Return on Assets mean to Investors?

The return on assets, or ROA, is a fundamental and practical method used by investors to grasp a better understanding of the financial well-being of a company. ROA tells how efficiently a company is able to convert its asset purchases into net income for itself and the investors. ROA carves out a company’s performance and is used to gauge a company’s performance. When a firm’s ROA rises, it shows that the company is squeezing more profits out of each rupee it owns in its assets. Conversely, a lower or declining ROA suggests a company has made unfavorable investments and is also spending too much money, and the financial well-being of the company is compromised. Investors made the following observations from the ROA trends:

1. Higher Return on Assets Ratio: For those companies that have an ROA higher than the same set of companies, it can be assumed that the company’s assets are being used at their full capacity, or at the very least, used more efficiently than their industry standards.

2. Lower Return on Assets Ratio: For those companies that have a lower ROA relative to industry standards, this is often considered a red flag, indicating that management might not be deriving the full potential benefits from the assets deployed.

3. Increasing Return on Assets (ROA): For a company whose ROA is rising over time, investors’ observation in this regard is that the company is improving its ability to increase its profits with each rupee of assets owned.

4. Decreasing Return on Assets (ROA): For a company whose ROA is declining over time, this indicates that the company might have invested in too many assets and/or is failing to utilize its assets to their full capacity, which is a point of a query for investors.

Difference Between Return on Assets and Return on Equity

Return on assets and return on equity are known as profitability ratios, as both of these formulas indicate the level of profit generated by a business and provide a financial overview of the company. The major difference between return on assets (ROA) and return on equity (ROE) is that the ROA metric does not factor in debt in a company’s capital structure.

Basis	Return on Assets	Return on Equity
Introduction	It measures how much profit the business generates with the amount of total assets invested in the business.	It measures how much a business earns with regard to the amount of equity invested in the business.
Difference in Denominator	This ratio is calculated with net income as the numerator and total assets as the denominator.	While calculating return on equity, the ratio is calculated with net income as the numerator and total equity as the denominator.
DU Pont Analysis	No such measures are applicable for the calculation of the return on assets.	ROE is also calculated using du Pont analysis, which helps identify whether the ROE has increased due to a change in net profit margin or leverage or whether it is due to an increase in asset turnover.
Investors	Whereas ROA measures how much profit the business has generated considering the funds invested by both equity shareholders and preferred shareholders, all these investors provide the total debt investment as the funds required for the total assets.	For the calculation of ROE, only equity investors are considered.
Adjustment	As in the case of calculating total assets, both equity and debt holders are considered, and interest expenses must be added back to the net income, which is used in the numerator of the ratio.	For the purpose of calculating ROE, there is no requirement to adjust the ratio’s numerator, as the denominator only comprises equity and is not a combination of both equity and debt.

Benefits of Return on Assets

1. Gives an Overview: The ROA figure helps to give investors an idea of how effectively the company is able to convert the money it invests into net income. To put it simply, a higher ROA means more asset efficiency.

2. Provides view Including Debt: ROA factors also show investors how leveraged a company is or how much debt it carries. The total assets include all capital the company borrows to run its operations.

3. Comparative Analysis: ROA helps to give a comparative analysis of the companies within the same industry standards, provides information about financial well-being, and helps to make an informed business decision.

Limitations of Return on Assets

1. Not Applicable Across Industries: The thing is, ROA is not applicable to all types of industries. This is because each type of organization has a different framework and possesses diverse asset bases. Comparing two industry ROAs that are not related will not provide fruitful results. For example, companies in the real estate industry do not have the same asset base as those in the manufacturing industry.

2. Usage of Total Assets: The denominator of the formula to calculate ROA is to be taken from a single point in time to calculate total assets. This ignores the instance when the business is engaged in acquiring new assets or has engaged in the sale of assets. For the same reason, analysts and investors have used average assets as the denominator to reflect the true picture.

3. Inclusion of Net Profit: While calculating ROA, net profit can highly impact the ROA calculation. The management possesses a certain degree of ability to manipulate the net profit amount. They could put off some discretionary spending in order to boost revenues and inflate net profits. Also, a company can inflate its revenue by adding unrealistic sales. They could also outsource production operations, which are more asset-intensive operations so that they can lower their overall asset investment. This, as a result, might not show the desired results.

Frequently Asked Questions (FAQs)

What is ROA?

Return on assets, also referred to as ROA, is one of the fundamental financial ratios that is used by investors and other stakeholders to determine how profitable a company is for the total assets deployed. Users of this financial ratio include corporate management, analysts, investors, creditors, etc. who use the return on assets formula to determine how efficiently a company utilizes its assets to generate a profit.

What is ROE? And how is it different from ROA?

ROE or Return on Equity, measures how much a business earns with regard to the amount of equity invested in the business. ROA is used to assess the profitability of a company against its total assets. whereas, ROCE measures a company’s profitability against the capital employed.

What is the formula for ROA?

What is considered a good ROA?

Generally, A ROA of 5% or above is considered as a good indicator of financial well being, and a ROA of 20% or higher is considered excellent. However, it is important to compare the ROA of those companies which have the same asset base.

What does ROA interpret?

ROA tells how efficiently a company is able to convert its asset purchases into net income for itself and the investors. ROA carves out companies performance and is used to gauge a company’s performance. When a firm’s ROA rises, it shows that the company is squeezing more profits out of each rupee it owns in its assets. This helps the investor to make informed investment decision.