Return on assets (ROA) is a profitability ratio that measures the rate of return on resources owned by a business. It is one of the different variations of return on investment (ROI). It measures the level of net income generated by a company’s assets.
The return on assets is a cross-financial statement ratio. It makes use of “net income” derived from the income statement and “total assets” obtained from the balance sheet.
The formula for return on assets is:
Net Income ÷ Average total assets
Take note that it is better to use average total assets instead of simply total assets. This is because the net income represents activity for a period of time; however, total assets is measured as of a certain date. To somehow fix this mismatch, the average of the beginning and ending balance of total assets is used.
| Company A | |||
| 2021 | 2020 | ||
| Net income (from income statement) | 8.3 million | 5.6 million | |
| Total assets (from balance sheet) | 90 million | 80 million | |
| Company B | |||
| 2021 | 2020 | ||
| Net income (from income statement) | 5.7 million | 3.6 million | |
| Total assets (from balance sheet) | 45 million | 30 million | |
| Return on assets | = | Net income |
| Average total assets |
| Company A | = | 8.3 |
| (90 + 80) ÷ 2 | ||
| = | 9.8% |
| Company B | = | 5.7 |
| (45 + 30) ÷ 2 | ||
| = | 15.2% |
Assuming that the companies operate in the same industry and economic environment, it can be concluded that Company B did better in managing its resources to generate profits.
Just like other variations of rate of return, the higher the return on assets the better. A high return on assets means than the business was able to utilize its resources well in generating income. It is also noteworthy to mention that this ratio removes the effect of company size. As illustrated in the example above, even if Company A generated 8.3 million and Company B generated 5.7 million only, Company B was more efficient since it made more income for each dollar of its assets. Also, the return on assets becomes more useful when it is compared to the industry average or other benchmarks such as historical performance or a target return.
Return on assets (ROA)
