Return on Assets Ratio (ROA)

The ROA is a tool used to measure how well a company uses its assets to generate earnings.
It measures the percentage of how much income a company’s net operating profit, after taxes, has earned annually on average over three years from all the business operations and investments.
ROA shows what happened with a firm’s historically acquired resources. It gives an idea as to how efficient the management is at using its assets to generate earnings.

Importance of Return on Assets Ratio

ROA is an indicator of performance that incorporates the company’s asset base.

  • ROA is very useful in differentiating between competing companies and can be used to compare similar companies within the same industry. 
  • It provides information about the relationship between income and assets employed. 
  • It takes into consideration all types of assets, like working capital, property, equipment, and investments in securities. 
  • It is a very good measure of management performance. 
  • ROA focuses attention on the assets being used to generate earnings for shareholders investors. 

How Can You Calculate ROA 

ROA provides information about how efficiently a company uses its assets to generate earnings. To calculate the ROA, here is the formula:

ROA Calculation formula

Since ROA is expressed in percentage, the result of dividing the net profit by the average total assets should be multiplied by 100.

ROA computation Sample

What Are the Benefits of Using ROA as a Measure of Performance

ROA is very useful in differentiating between competing companies and can be used to compare similar companies within the same industry. 

  • It provides information about the relationship between income and assets employed. 
  • ROA demonstrates how efficient management is at utilizing its resources. 
  • ROAs that are higher than 15% indicate that a company has generated more profit for each dollar of assets it has employed. 
  • ROA can be used as a predictor of future earnings. 

Return on Assets (ROA) vs Return on Equity (ROE)

Both ROA and ROE are good measures of performance since both measures how a company utilizes its assets. 

ROA

ROA looks at the use of assets to generate earnings. The ROA ratio gives a better picture of how efficiently a company is utilizing its assets since it accounts for a company’s debt.

If the ROA is increasing over time, it means that the company has been using its assets more efficiently to produce income. 

ROE

ROE focuses on common equity only. It does not account for the company’s debt, leaving out the liabilities.

If ROE is increasing over time it means that the company has been using a smaller percentage of its assets to produce income.

The Importance of Calculating ROA With Other Ratios, Such as Debt-To-Equity and Profit Margin 

ROA vs Debt-to-Equity

ROA shows how efficiently a company is using its assets, while the debt-to-equity ratio provides more information on how well a company can pay off its liabilities. 

Higher ROA ratios indicate that more profit has been generated from the assets.

Lower ROA ratios indicate that less profit has been generated from the assets. This can mean that management is not as efficient at utilizing its assets to generate income, or that it is taking on more liabilities than necessary to produce income.

ROA vs Profit Margin Ratio

Both ROA and profit margin can be used to show how efficient a company is in terms of its assets and expenses. ROA focuses on total net income while profit margin concentrates on net income after taxes. 

Limitations of ROA Ratio

There are two popular limitations of Return of Assets Ratio.

ROA could be affected by the type of industry in which a company operates.

If ROA is calculated for companies in different industries, it will not be very meaningful since ROAs vary widely among industries and groups of companies within the same industry. 

ROA Does Not factor in how long a company has been generating earnings.

ROA shows how well a company is currently utilizing its assets but does not take into consideration the conditions under which the assets are being used.

ROA Does Not Explain Its Increase or Decrease.

Another limitation is that ROA is not very useful in explaining why ROA increased or decreased. This is because ROA is calculated based on historical data, not future projections.

What Are the Disadvantages of ROA as a Measure for Performance?

The disadvantages of ROA include the following: 

  • ROA does not use future projections. 
  • ROA shows historical information and is a backward-looking measure. 
  • ROA does not provide an answer to the question of why ROA increased or decreased. 
  • ROAs vary widely among companies within the same industry, making ROAs incomparable unless they are for exactly the same type of company.

The Bottom Line

Since ROA shows how efficiently a company is utilizing its assets to generate earnings, ROA can be used for comparison purposes of the same industry. RO

ROA can also be used to predict future earnings. ROA is important, but ROA does have its limitations, such as not including the use of debt. 

ROA should be used in conjunction with other financial ratios, such as ROE and profit margin, for a better indication of performance efficiency. 

ROA shows how efficiently a company is utilizing its assets to generate earnings. ROA ratio shows whether or not the company is using its assets efficiently for generating income.
ROA can be used to compare firms within the same industry, but ROA varies widely among companies within the same industry, making ROAs incomparable unless they are for exactly the same type of company.
ROA shows how efficiently a company is using its assets to generate revenue and become profitable. ROA allows investors to determine if the company has been utilizing its assets to produce net income and helps in ROE, ROI, and ROA comparison.
ROA = Net Income / Total Assets*100%
ROA allows investors to determine if the company has been utilizing its assets to produce net income. ROA helps ROI, ROE, and ROA comparison

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.