Return on Assets - RoA

What is ROA & its significance:

Return on Assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA
gives an idea as to how efficient management is at using its assets to generate earnings. Calculated
by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage.
Sometimes this is referred to as "Return on Investment". (ROI)
The formula for return on assets is: Net Income
Total Assets
Meaning of ROA
ROA tells you what earnings were generated from invested capital (assets). ROA for public
companies can vary substantially and will be highly dependent on the industry. This is why when
using ROA as a comparative measure, it is best to compare it against a company's previous ROA
numbers or the ROA of a similar company.
The assets of the company are comprised of both debt and equity. Both of these types of financing
are used to fund the operations of the company. The ROA figure gives investors an idea of how
effectively the company is converting the money it has to invest into net income. The higher the ROA
number, the better, because the company is earning more money on less investment.

Significance of ROA

ROA tells 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 example, if one company has a net income of Rs 1 million and total assets of Rs 5 million,
its ROA is 20%; however, if another company earns the same amount but has total assets of
Rs 10 million, it has an ROA of 10%. Based on this example, the first company is better at
converting its investment into profit. When you really think about it, management's most
important job is to make wise choices in allocating its resources

ROA shows how companies have two choices in improving efficiency.

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Companies can raise prices and create high margins or rapidly move assets
through the company. Either way (or both) improves ROA.

Limitations of ROA

Falling ROA is almost always a problem, but investors and analysts should bear in mind that
the ROA does not account for outstanding liabilities and may indicate a higher profit level
than actually derived

ROA is an important measure to use and understand, but its flaw is that the metric does
not consider the effect of borrowed capital.

Things to Remember

The ROA is often referred to as ROI

The number will vary widely across different industries, but in general, the higher the ROA
the better.

Return on assets gives an indication of the capital intensity of the company, which will depend on
the industry; companies that require large initial investments will generally have lower return on
assets. ROAs over 5% are generally considered good.

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