How Can Business Acumen Help You to Understand Your Return on Assets?
What is ROA?
ROA, or Return on Assets, is a word you've probably heard before. Knowing and understanding it will be beneficial in your business conversations and help you progress in your career.
ROA is a very important measure that provides a ratio of net income divided by the total assets of a company. Why is this important? By having a ratio you can gain insight into what total assets were required to generate the profit at any company. In isolation, profit does not tell you what was required to generate that profit. For example, two companies can generate the same profit of $10 million. One company has $100 million dollars in assets and the other company has $10 million in assets. By being able to put it into a ratio format you can see what's the profit relative to the total assets available to the management team to generate that profit.
What can you learn from the number itself? Well, the higher the ROA in general means the more efficient a company is at generating a profit relative to the assets that it has. The lower the ROA may indicative of challenges or opportunities for the company.
Generally, the most important thing is how things are trending. Is it continuing to go up? Is it continuing to go down? And ROA can be a way for management to keep an eye on “are we purchasing the right assets to get the best return on our investments?”
Now every measure has its strengths and weaknesses. And it's important to understand that the key strength of ROA is its simplicity of it. Typically, the common calculation is going to be net income divided by total assets, but some companies have some variations like using net income divided by average assets or using a modified net income.
ROAs are perfect for comparing across companies and seeing trends, but what are the weaknesses? Well, the weaknesses are that not all assets are created equal, right? We get a total asset value but there's no insight into what kind of assets we're talking about. One company might have a lot of cash, it might have a lot of goodwill. Another company may be very heavy on capital equipment, facilities, locations, and plants. There's really no additional insight to that. So the simplicity which is its greatest strength is also its weakness, in that it doesn't really distinguish what kind of assets you have, how it's deployed, etc.
A common question is: what is a good return on asset number? The answer in finance and accounting is always the same — it depends. It depends on so many different nuances, so many different factors. But in general, five percent or greater is going to be a good ROA. In some industries, that might be pretty weak. Again, it all depends. But a15 to 20 percent ROA is really strong.
People often ask what are some of the other measures that are similar to ROA? There's a whole family of measures we refer to as the return on measures. They're typically a ratio of "what's the benefit?" Some common ones are return on invested capital, return on equity, return on capital employed.
So to summarize return on assets — ROA — is net income divided by total assets. It gives you a great insight into the efficiency of a company and how well a company generates a profit relative to the assets that they have.
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