It is useful for an investor to learn how to calculate a financial ratio known as “Return on Assets” (ROA). This ratio is a measure of management performance commonly used to compare different companies and their asset utilization.
Return on Assets Formula
The standard method for calculating Return on Assets is to compare net income to the total assets of the company at a specific point in time:
ROA = Net Income ÷ Total Assets
The first formula requires you to input the net income and total assets of the company before you can find the ROA. In most cases, these are line items on the income statement and the balance sheet. Using the 2019 reports from Best Buy Co., we can use this formula to find the ROA for the company. Page 109 of the company’s annual report contains the ROA calculation for the last seven years.
ROA = $1.464 billion ÷ $12.994 billion
ROA = 0.113 or 11.3%
In general, publicly traded companies report their net income, or profits, in their income statement and total assets on the balance sheet at times throughout the year: annually, quarterly, and monthly. If you are looking for figures over a period rather than at the time of the annual report, use the average assets method to calculate ROA. Just take the average assets over the desired period instead of a single point in time.
ROA = Net Income ÷ Average Assets
You need to keep in mind that a company’s assets can fluctuate suddenly. For example, this might happen if the company decides to sell off several large pieces of equipment. For this reason, using average assets to calculate ROA is often considered a better measure.
Return on Operating Assets
Another standard measure of assets and the return they generate is “Return on Operating Assets” (ROOA). It is similar to ROA in that it measures the return on assets. However, ROOA measures the return on the assets that are actually in use.
ROOA is calculated by subtracting the value of unused assets from the total asset value, then dividing net income by the result.
ROOA = Net Income ÷ (Total Assets – Unused Assets)
Companies that continue to operate usually track the ups and downs of the business cycle, where supply and demand fluctuate in an attempt to stabilize. When demand rises, companies will increase the number of assets they use to produce their goods and services.
When demand decreases, most companies will sell off assets to recover some cash, but they will typically retain some assets as a cushion to reduce spending during the next uptick in demand. ROOA takes into account that not all assets are actively used at any given time.
With this in mind, ROOA is a more accurate measure of how assets are being used to generate income.
Importance of Return on Assets
ROA allows you to see how much profit after expenses a company generates for every dollar in assets. In other words, ROA measures the company’s net income relative to all the resources it has available.
ROOA measures the efficiency of the assets that are being utilized. These metrics are indicators of management efficiency in using assets. This is a key profitability metric. It aims to provide investors with insights into shareholder revenue generation.
It is often believed that a higher ROA is better than a lower ROA. However, you should be cautious when using this ratio. ROAs cannot be compared across industries. Sometimes, they cannot even be used to compare companies within the same industry, as each company operates and manages its assets in different ways.
For ROA and ROOA to be effective comparison tools, the companies must be very similar in structure and practice. It is also wise to look at these ratios regularly. They can change significantly over time, based on business performance and asset utilization.
Questions
Frequently Asked Questions (FAQs)
What is a good return on assets?
The average ROA varies significantly by industry. The main driver of a company’s ROA is net income, and some industries have lower profit margins than others. Retailers and restaurants rely on raw goods and commercial spaces that make the average profit margin lower than something like an online bank, which has lower overhead costs.
How can I find a company’s return on assets?
The balance sheet will contain the profit and asset information you need to calculate ROA. Most companies make these financial documents easily accessible. Check the company’s website for an investor relations page. If you can’t find the information there, the SEC has a database of financial reports you can use.
Source: https://www.thebalancemoney.com/return-on-assets-roa-357592
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