What is Return on Assets All About?

We recently took a look at a profitability ratio called the Operating Cash Flow Margin, but did you know that there are lots of profitability ratios you can use to gauge the financial health of your small business? One of them is called the Return on Assets.

What is Return on Assets and How Do I Calculate It?

Return on Assets (simply abbreviated as ROA) is one way for you to calculate how good your assets are at generating revenue. Once calculated, ROA is expressed as a percentage. The calculation is pretty straightforward: all you need to do is divide net income by average total assets:

ROA = Net Income / Average Total Assets

Before looking at an example of how to find a company’s ROA, let’s brush up on the meaning of the terms used in the formula above. First, net income: also known as the “bottom line.” This is your business’s earnings for a given period once you have subtracted expenses, taxes, and the cost of goods sold (COGS). You can find net income on your income statement. Average total assets are found by adding together the total amount of assets (found on your balance sheet) at the end of the current fiscal year with the total amount of assets from the preceding year, and dividing the result by two.

Now that we have a better idea of the terms making up our formula, let’s take a look at an example. Let’s say your company had a net income of $250,000 this year. Total assets for this fiscal year totaled up to $1.5 million, while last fiscal year they added up to $1 million. First, let’s find the average total assets: $1.5 million + $1 million = $2.5 million. Divide $2.5 million by 2, and we get average total assets of $1.25 million. Let’s plug these numbers into the ROA equation:

ROA = Net Income / Average Total Assets

ROA = $250,000 / $1,250,000

ROA = 0.20 or 20%

What’s the Ideal Ratio?

As you may have already guessed, ROA can vary wildly from company to company and industry to industry. This is mainly because some businesses are just more asset-intensive than others by the nature of what they do. Companies that rely on a lot of expensive equipment (part of their assets) to manufacture their product are an example of asset-intensive business. Naturally, the expectations around their ROA would have to take that factor in to account.

For this reason, most investors will be interested in comparing your ROA to the ROA of similar companies in your industry. Comparing your own company’s ROA year over year is another option in terms of gauging how effective your business is at utilizing its assets to generate profit. If you’re seeing an upward trend in ROA, that’s great! It means that your business’s profitability is improving, which is essential to not only sustaining your business, but allowing it to thrive.


Originally published at www.kashoo.com.