Return on Assets (ROA) Ratio : Formula and "Good" ROA Defined (2024)

What Is the Return on Assets (ROA) Ratio?

Return on assets (ROA) is a financial ratio that indicates how profitable a company is relative to its total assets. Corporate management, analysts, and investors can use the return on assets ratio to determine how efficiently a company uses its resources to generate a profit.

Understanding Return on Assets (ROA) Ratio

The return on assets ratio is commonly expressed as a percentage using a company’s net income and average assets. A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits. A lower ROA indicates there's room for improvement.

Businesses are about efficiency. Comparing profits to revenue is a useful operational metric but comparing them to the resources a company used to earn them displays the feasibility of that company’s existence. Return on assets is the simplest of these corporate bang-for-the-buck measures. It reveals what earnings are generated from invested capital or assets.

ROA for public companies can vary substantially and are highly dependent on the industry in which they function. The ROA for a tech company won’t necessarily correspond to that of a food and beverage company. It's best to compare a company's ROA against its previous ROA numbers or a similar company’s ROA when using it as a comparative measure.

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.

A similar valuation concept is a return on average assets (ROAA) which uses the average value of assets instead of the current value of the item. Financial institutions often use ROAA to gauge financial performance.

Return on Assets Ratio: Formula and Calculation

The return on assets ratio is calculated by dividing a company’s net income by its total assets. It’s expressed as a formula like this:

$Return\ on\ Assets = \frac{Net\ Income}{Total\ Assets}$ReturnonAssets=TotalAssetsNetIncome​

Let's say that Sam and Milan both start hot dog stands. Sam spends $1,500 on a bare-bones metal cart. Milan spends $15,000 on a zombie apocalypse-themed unit, complete with costume.

Let’s assume that those were the only assets each firm deployed. Milan would have the more valuable business but Sam would have the more efficient one if Sam earned $150 and Milan earned $1,200 over a given period. Sam’s simplified ROA is $150 ÷ $1,500 = 10% using the above formula. Milan’s simplified ROA is $1,200 ÷ $15,000 = 8%.

Special Considerations

Total assets are also the sum of its total liabilities and shareholder equity because of the balance sheet accounting equation. Both types of financing are used to fund a company’s operations. A company’s assets are either funded by debt or equity so some analysts and investors disregard the cost of acquiring the asset by adding back interest expense in the formula for ROA.

The impact of taking more debt is negated by adding back the cost of borrowing to the net income and using the average assets in a given period as the denominator. Interest expense is added because the net income amount on the income statement excludes interest expense.

Return on Assets (ROA) vs. Return on Equity (ROE)

Both ROA and return on equity (ROE) measure how well a company uses its resources. But one of the key differences between the two is how they each treat a company’s debt. ROA factors in how leveraged a company is or how much debt it carries. Its total assets include any capital it borrows to run its operations.

ROE only measures the return on a company’s equity which leaves out its liabilities. ROA accounts for a company’s debt and ROE does not. The more leverage and debt a company takes on, the higher ROE will be relative to ROA. A company's ROE would be higher than its ROA as it takes on more debt.

Assets are now higher than equity and the denominator of the return on assets calculation is higher because assets are higher, assuming returns are constant. A company’s ROA falls as its ROE stays at its previous level.

Limitations of the ROA Ratio

One of the greatest issues with the return on assets ratio is that it can’t be used across industries because companies in one industry have different asset bases from those in another. The asset bases of companies within the oil and gas industry aren’t the same as those in the retail industry.

Some analysts also feel that the basic ROA formula is limited in its applications because it's most suitable for banks. Bank balance sheets better represent the real value of their assets and liabilities because they’re carried at market value via mark-to-market accounting or at least an estimate of market value versus historical cost.

Debt and equity capital are strictly segregated for nonfinancial companies as are the returns to each:

• Interest expense is the return for debt providers
• Net income is the return for equity investors

The ROA calculation has an inconsistent numerator and denominator. The numerator shows returns to equity investors or net income but the denominator shows assets funded by both debt and equity investors or total assets. Two variations on this ROA formula fix this numerator/denominator inconsistency by putting interest expense net of taxes back into the numerator. The formulas would be:

• ROA Variation 1: Net Income + [Interest Expense × (1 - Tax Rate)] ÷ Total Assets
• ROA Variation 2: Operating Income × (1 - Tax Rate) ÷ Total Assets
  

Example of ROA Ratio

The return on assets ratio is most useful for comparing companies in the same industry because different industries use assets in varying ways. The ROA for service-oriented firms such as banks will be significantly higher than the ROA for capital-intensive companies such as construction or utility companies.

Let’s evaluate the normalized ROA for three companies in the retail industry:

• Macy’s (M)
• Kohl’s (KSS)
• Dillard’s (DDS)

The data in this table is accurate as of Jan. 31, 2024, according to Macrotrends and Yahoo! Finance. This table is normalized. It doesn't include non-recurring expenses.