Alternative names: ROA
Return of asserts is a financial indicator that shows how profitable a business in a relationship to its total assets. In other words, how efficient a business is to use its assets to generate profit. The higher the return the more efficient the management might be at using its resources. It is important to notice that, unlike Return on Equity, the Return on Assets does take into account all assets regardless of its liabilities to creditors. Therefore the more leveraged a company is, the higher ROE will be relative to ROA. The reason for this is because when debt increases, equity decrease, and since equity is the ROE's denominator in the formula therefore ROE becomes larger. Another way of looking at it is that Return on assets shows how efficiently a company can convert the money used to purchase assets into profits.
Return on assets formula is calculated by dividing the net income of the company by its total assets:
ROA = Net Income / Total assets (or Average Total assets)
A construction company that has assets on its balance sheet in the being of the year $1,000,000 and an end of the year of assets of $2,000,000. The company profit for the same year is $500,000.
The Return on assets of the company will be:
$500,000 / (($1,000,000 + $2,000,000 )/2) =$500,000 / $1,500,000 = 30%
As you can see in the example above the return on assets of the company is 30% or in other words for every $1 invested in assets of the company, the business is generating $1.3.
Return on assets is a measurement of how capital intensive a company is. Obviously, the capital intensiveness of a business will be highly dependent on the industry that the business is operating in. More capital intensive industries, like construction companies and railroads, require that businesses have a lot of assets in order to be able to operate and compete and therefore this businesses will have lower return of assets. Conversely in industries where businesses don’t have the need for a lot of to operate and compete, like software industries and services based industries, businesses will have a lot higher return on assets. That is why when assessing ROA for a company it is important to compare the values with the company historical performance as well as with comparable businesses in the same or similar industry.
Since return on assets is an efficient ration, the larger the return on equity the better and more efficient the company is at using its assets to generate profit. The ROA ratio is highly industry dependent but as a general rule any ROA higher than 20 is considered very good.