Return on Assets

ROA is a financial ratio that measures a company’s profitability in comparison to its total assets. Managers, analysts, and investors can use ROA to assess a company’s ability to generate a profit. By using a company’s net income and average assets, the ROA metric is commonly expressed as a percentage. The better a company is at managing its balance sheet to generate profits, the higher its return on assets (ROA), while the lower its ROA, the more room there is for improvement.

Calculating return on assets

It is an easy process. Simply divide a company’s net profit by its total assets, then multiply the result by 100 to calculate ROA.

Return on assets = (Net Profit / Total Assets) x 100

Net profit is reported on income statements by public companies, and total assets are disclosed on monthly, quarterly, or annual balance sheets. A company’s quarterly earnings reports usually include these statements. Assume a company made $3 million in net profit in 2021 and had $15 million in assets at the end of the year. You can calculate the company’s ROA for 2021 by dividing $3,000,000 by $15,000,000, which gives you 0.2. Then you must multiply this amount by 100, which gives you an ROI of 20%. For every dollar in assets owned by the company, they make 20 cents in profit.

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Using the Return on Assets

The return on assets is a useful metric for evaluating the performance of a single company. This indicates that the firm is getting more value out of each dollar invested in assets when ROA increases. In contrast, a declining ROA suggests that a company has made poor investments, is overspending, and may face trouble in financial matters.

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When comparing ROAs between companies, you should proceed with extreme caution. It is impossible to compare companies of different sizes or industries using ROA. When comparing companies in the same industry, even those with comparable sizes and different stages of development may have a wildly divergent return on assets.

As a result of these considerations, it is best to use ROA to analyze a single business over time. Tracking a company’s ROA quarterly or annually can help you determine how well it is performing. ROA is a good indicator of long-term changes in the company.

What Is a reasonable ROA?

A ROA of at least 5% is good and when it is perfect when it is more than 20%. The higher a company’s ROA, the more efficient it is at making money. However, the ROA of any given company must be viewed in light of the ROAs of its counterparts in the same sector or industry.

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For example, a car manufacturer may have a ROA of 7%, whereas a video games company may have a ROA of 16%. Investing in a video game company would be the better choice if you only looked at their ROAs. But if you compare the car company to its competitors, which all may have ROAs of under 3%, you find that it’s doing better than its rivals in this industry. The opposite is also true; By comparing the video game company’s ROA to similar technology companies, you may find its ROA significantly lower than its competitors.

Return on Assets vs. Return on Equity

Similar to ROA, the return on equity ratio (ROE) can be used to measure the performance of a particular business. One way to calculate ROE is to divide net profits for the given period by shareholders’ equity; this indicates the company’s ability to utilize its capital.

ROA measures the way a company manages its assets to make money; However, the way a company manages the money invested by its shareholders is measured by ROE. The return on equity (ROE) is a metric used by investors to gauge the effectiveness of their stock investments. ROA’s measure of a company’s asset efficiency complements the findings drawn from ROE.

Conclusion

If you want to invest in a company and buy its shares, you should make sure whether your investment is profitable or not. Technical analysis cannot always help you find the right spots for investing. You can easily invest in big companies like Apple, Microsoft, or Amazon without hesitation. However, when it comes to smaller companies making a decision can be challenging. The most important factor in investment is receiving a reasonable profit. The return on asset ratio can help you find the right company for investment based on the amount of profit you can receive. Therefore it is logical to calculate the ROA of a company before making a decision.