Return on Assets ROA: Formula and ‘Good’ ROA Defined

With 2019 filings from Best Buy Co., we can use this formula to find the company’s ROA. Page 109 of its annual report has the ROA calculated for the prior seven years. This number tells you what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. It’s a useful number for comparing competing companies in the same industry.

For instance, the ROA for a tech firm won’t necessarily tally with the ROA of a food and beverage firm. A rising ROA may indicate a company is generating more profit versus total assets. Companies with rising ROAs tend to increase their profits, while those with declining ROAs might be struggling financially due to poor investment decisions. Return on assets compares the value of a business’s assets with the profits it produces over a set period of time. Return on assets is a tool used by managers and financial analysts to determine how effectively a company is using its resources to make a profit. Return on assets (ROA) is a measure of how efficiently a company uses the assets it owns to generate profits.

What is Return on Assets?

Because of this, an ROA shoots straight for the heart of a company’s stability. Using ROA, you can determine what a company is built on and what they are doing with it. Increasing the net income or decreasing the total asset of a company can cause a rise in the return on assets. A typical ROA will vary depending on the size and industry that a company operates in. Be careful when comparing the ROAs of two companies in different industries.

ROA can be used to determine how well a company is performing in comparison to its industry peers. For example, if a company has a higher net income than a competitor, it might appear that the company is performing better. However, if the other company stationery is an asset or an expense has a significantly higher ROA, that company is utilizing its capital and assets more efficiently than the first company. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm’s activities.

Return on Assets Formula

However, debt financing is not necessarily a bad thing, as far as the management uses it effectively to generate earnings. For example, an auto manufacturer with huge facilities and specialized equipment might have a ROA of 4%. On the other hand, a software company that sells downloadable programs that generates the same profit but with fewer assets might have a ROA of 18%.

Say your business is in the technology industry, and the average ROA is 14.50%. While Acme is able to realize 10% profit for every dollar it has in assets, Build It is able to realize 16% profit for every dollar it has in asset. This is a great demonstration of how ROA can help investors understand the differences between companies to determine which is the better investment. Acme Company is a manufacturing company with a net income of $100 million and $1 billion in total assets.

What Return on Assets (ROA) Means to Investors

The ROA calculation can be used to make comparisons across companies in the same sector or industry. The ratio is an indicator of performance that incorporates the company’s asset base. Calculating the ROA of a company gives information about the relationship between the company’s income and assets employed. However, a higher ROA than average may not always be a good sign of efficiency. It could also mean that the company isn’t investing enough in assets, which cause problems in the future. More so, some companies make it look like the ROA is exceptionally high by finding ways to keep their assets off the books.

• Companies with rising ROAs tend to increase their profits, while those with declining ROAs might be struggling financially due to poor investment decisions.
• Having more debt is not bad as long as management uses it effectively to generate earnings.
• ROA provides information about how efficiently a company uses its assets to generate earnings.
• These profitability ratios are used to measure a company’s performance.

Since ROA is expressed in percentage, the result of dividing the net profit by the average total assets should be multiplied by 100. Once you’ve determined the average value of a company’s assets, divide net profit by average assets and multiply it by 100 to get the percentage. Charlie’s Construction Company is a growing construction business that has a few contracts to build storefronts in downtown Chicago.