What Is the Cash Return on Assets Ratio?
The cash return on assets (cash ROA) ratio is used to benchmark a business's performance with other businesses in the same industry. It is an efficiency ratio that rates actual cash flows to company assets without being affected by income recognition or income measurements. The ratio can be used internally by the company's analysts or by potential and current investors.
Key Takeaways:
- The cash return on assets (cash ROA) ratio is used to benchmark a business's performance with other businesses in the same industry.
- Cash ROA rates actual cash flows to assets without being affected by income.
- The ratio is useful to company analysts or potential and current investors.
- A high cash ROA ratio typically indicates that a company earns more net income from $1 of assets than the average company, which is a sign of efficiency.
- A low cash ROA ratio typically indicates that a company makes less net income per $1 of assets, which is a sign of inefficiency.
Understanding the Cash Return on Assets Ratio
Fundamental analysts believe a stock can be undervalued or overvalued. That is, fundamental analysts believe in-depth analysis can help increase portfolio returns. Fundamental analysts uses a variety of tools, including ratios, to assess portfolio returns. Ratios help analysts compare and contrast data points, such as return on assets (ROA) and cash ROA. When these two ratios diverge, it is a sign that cash flow and net income are not aligned, which is a point of concern.
ROA vs. Cash ROA
Return on assets is calculated by dividing cash flow from operations by average total assets.
CashReturnonAssets=TotalAverageAssetsCashFlowfromOperations
The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings.
A high cash ROA ratio means the company earns more net income from $1 of assets than the average company, which is a sign of efficiency. A low cash ROA ratio means a company makes less net income per $1 of assets, which is a sign of inefficiency.
The issue is that net income is not always aligned with cash flow. As a solution, analysts use cash ROA, which divides cash flows from operations (CFO) by total assets. Cash flow from operations is specifically designed to reconcile the difference between net income and cash flow. In this way, it is a more accurate number to use in the calculation of ROA than net income.
Example of Cash Flow and Net Income Misalignment
As an example, if Company A has a net income of $10 million and total assets of $50 million, ROA is 20%. Company A also has high sales growth due to a new financing program that gives all customers 100% financing. As a result, net income is high, but the increase in net income is the result of an increase in credit sales. These credit sales increased sales and net income, but the company has received no cash for sales.
Cash flows from operations, a line item that can be found on the cash flow statement shows the company has $5 million in credit sales. Cash flows from operations deducts this $5 million in credit sales from net income. As a result, cash ROA is calculated by dividing $5 million by $50 million, which is 10%. In actuality, assets generated a lower amount of "real" cash earnings than originally thought.
FAQs
Cash ROA. Return on assets is calculated by dividing cash flow from operations by average total assets. The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings.
What is a good cash return on asset ratio? ›
When the return on assets ratio falls below 5%, it is considered low. And when the ratio exceeds 20%, it's considered excellent. Average ratios can vary significantly from one industry to another.
What does the return on assets ratio tell you? ›
Return on assets is a profitability ratio that provides how much profit a company is able to generate from its assets. Return on assets (ROA) measures how efficient a company's management is in generating profit from their total assets on their balance sheet.
What does a return on assets of 12.5% represent? ›
What does a return on assets of 12.5% represent? A return on assets (ROA) of 12.5% means that for every $100 of total assets on the company's balance sheet, it generates $12.50 in net income.
What does cash to total assets ratio mean? ›
The Cash to Assets Ratio is a measure of the proportion of a company's Assets that are made up of Cash and Short Term Investments. It is calculated as Cash divided by Total Assets.
How to interpret cash return on assets? ›
Cash ROA. Return on assets is calculated by dividing cash flow from operations by average total assets. The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings.
Is 7% return on assets good? ›
Return on assets (ROA) is a key gauge of a company's profitability. The ROA ratio measures a company's net income relative to its total assets. A good ROA depends on the company and industry, but 5% or higher is considered good.
What is a bad return on assets? ›
What is considered a good and bad return on assets? A good return on assets is in the 10% range. Anything above that is excellent and below 5% is considered harmful. A company with a ROA of 15% or higher is doing very well, while one with 1% or lower is likely in trouble.
Is return on assets better high or low? ›
The ROA figure gives investors an idea of how effective the company is in converting the money it invests into net income. The higher the ROA number, the better because the company can earn more money with a smaller investment. A higher ROA means more asset efficiency.
What is the standard for a good return on assets ratio? ›
An ROA of 5% or better is typically considered good, while 20% or better is considered great. In general, the higher the ROA, the more efficient the company is at generating profits.
increase Net income: To improve ROA, focus on increasing net income by boosting revenue and reducing expenses. implement cost-cutting measures, negotiate better deals with suppliers, or explore new markets to drive sales.
Is return on assets equal to profit margin? ›
Ratios: Profit Margin x Asset Turnover = Return On Assets.
What is return on assets an indicator of? ›
An indicator of profitability.
ROA indicates how efficiently a company can turn its assets into profit. A higher ROA suggests that a company is using its assets effectively to generate earnings, which implies lower risk for lenders because it indicates the company's capability to service its debt.
What is a good cash to assets ratio? ›
There is no ideal figure, but a ratio of at least 0.5 to 1 is usually preferred.
What is a good cash flow to assets ratio? ›
Cash Flow to Assets Analysis:
It relates a company's ability to generate cash compared to its asset size. A ratio of 0.30 (30%) is quite good, Cory's Tequila Co. shouldn't run into any problems generating cash. When the ratio declines below 10% then there may be some cause for concern.
What is a good cash ratio? ›
There is no ideal figure, but a cash ratio is considered good if it is between 0.5 and 1. For example, a company with $200,000 in cash and cash equivalents, and $150,000 in liabilities, will have a 1.33 cash ratio.
What is a healthy cash to asset ratio? ›
Investors and analysts use the cash asset ratio to determine a company's liquidity. A ratio of 1 and above indicates a company is able to pay off its short-term obligations with its most liquid assets, while a ratio of under 1 may indicate financial difficulty.
Is 5% return on assets good? ›
A good return on assets is in the 10% range. Anything above that is excellent and below 5% is considered harmful. A company with a ROA of 15% or higher is doing very well, while one with 1% or lower is likely in trouble.
Is 3% a good return on assets? ›
A ROA of over 5% is generally considered good. Over 20% is excellent. ROAs should always be compared among firms in the same sector, however. A software maker has far fewer assets on the balance sheet than a car maker.
