What Is Return on Assets (ROA)?
Return on assetsis a profitability ratio that provides how much profit a company can generate from its assets. In other words, return on assets (ROA)measures how efficient a company’s management isin earning a profit from theireconomic resources or assets on their balance sheet.
ROA is shown as a percentage, and the higher the number, the more efficient a company’s management is at managing its balance sheet to generate profits.
Key Takeaways
- Return on assetsis a profitability ratio that provides how much profit a company is able to generate from its assets.
- Return on assets(ROA)measures how efficient a company’s management isin generating profit from theirtotal assets on their balance sheet.
- ROA is shown as a percentage, and the higher the number, the more efficient a company’s management is at managing its balance sheet to generate profits.
- Companies with a low ROA usually have more assets involved in generating profit, while companies with a high ROA have fewer assets.
- ROA is best when comparing similar companies; an asset-intensive company’s lower ROA might appear alarming compared to an unrelated company’s higher ROA with fewer assets and similar profit.
Calculating Return on Assets (ROA)
Average totalassets are used in calculating ROA because a company’s asset total can vary over time due to the purchase or sale of vehicles, land, or equipment, as well as inventory changes or seasonal sales fluctuations. As a result, calculatingthe average total assetsfor the period in question is more accurate than the total assets for one period.A company’s total assets can be found on the balance sheet.
The formula for ROA is:
Example of Return on Assets (ROA)
ExxonMobilCorp. (XOM)
Below is the balance sheet from ExxonMobil’s 10-K statement showing the 2021 and 2020 total assets.Note the differences between the two, and how this will affect the ROA.
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Below is the income statement for 2021 for ExxonMobil according to their 10-Kstatement:
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ExxonMobil’s ROA is more meaningful when compared to other companies within the same industry, such as Chevron and BP. Here are footnote links to their 2021ROAs.
Comparing a company’s return on assets (ROA) to similar companies can indicate how effectively the management invests in its future.
What Return on Assets (ROA) Means to Investors
Calculating the ROA of a company can be helpful in comparing a company’s profitability over multiple quarters and years as well as comparing to similar companies. However, no one financial ratio should be used to determine a company’s financial performance.
Interpreting ROA
When analyzing a company’s ROA, the following tends to be applicable:
- Companies with a low ROA usually have more assets involved in generating their profits.
- Companies with a high ROA usually have fewer assets involved in generating their profits.
As a result, companies with a low ROA tend to have more debt since they need to finance the cost of the assets. Having more debt is not bad as long as management uses it effectively to generate earnings.
A rising ROA tends to indicate a company is increasing its profits with each investment dollar invested in the company’s total assets. A declining ROA may indicate a company might have made poor capital investment decisions and is not generating enough profit to justify the cost of purchasing those assets. A declining ROA could also indicate the company’s profits are shrinking due to declining sales or revenue.
It’s important to compare a company’s ROA over multiple accounting periods. One year of a lower ROA may not be a concern if the company’s management team is investing in its future and it’s forecasted to increase profits over the coming years.
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.
Comparing ROA
It’s important to comparecompanies of similar size and industry. For example, banks tend to have a large number of total assets in the form of loans and investments. A large bank might have $2 trillioninassets and generate similar net income to an unrelated company in another industry. Although thebank’s net income might besimilar and have high-quality assets,its ROA might belower than the unrelated company.The larger total asset figure must be divided into thenet income, creatinga lower ROA for the bank.
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%. At first glance, the manufacturer’s 4% ROA might appear low vs. the software company. However, if the auto industry’s average ROA is 2%, then the auto company’s 4% ROA is outperforming its competitors.
When utilizing return on assets to compare productivity across businesses, it’simportant to take into account what types of assets are required to function in a given industry, rather than merely comparing the figures.
What Is ROA in Finance?
Return on assets(ROA) is a financial ratio that shows how much profit a company generates from its total assets.
How Do You Calculate Return on Assets?
Although there are multiple formulas, return on assets (ROA) is usually calculated by dividing a company’s net income by the average total assets. Average total assets can be calculated by adding the prior period’s ending total assets to the current period’s ending total assets and dividing the result by two.
What Is a Good Return on Assets Ratio?
A ROA of 5% or lower might be considered low, while a ROA over 20% high. However, it’s best to compare the ROAs of similar companies. A ROA for an asset-intensive company might be 2%, but a company with an equivalent net income and fewer assets might have a ROA of 15%.
What Does ROA Tell You?
A rising ROA may indicate a company is generating more profit vs. total assets. A declining ROA may mean lower profits vs. 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.
The Bottom Line
Return on assets (ROA) is an important metric for gauging the profitability of a company. It represents a company’s net income as a percentage of total assets. However, it is not the only relevant metric, and investors should make sure to look at the full picture when they compare different companies.
