Historical Background on the Return On Assets Ratio
This is a quick and simple measure for investors to gain an initial understanding of a company’s profitability, expressed as a percentage of the company’s total assets. The Return On Assets ratio therefore provides investors with an indication of how effectively management are deploying the company’s resources in order to generate an income return.
What is the Formula for Calculating the ROA ratio?
The Return On Assets ratio can be defined as follows:
Return On Assets (ROA) = ((Net income) / (Total Assets)) x 100
Industry & investors quote the ROA ratio as a percentage. A further alternative to the ROA calculation simply separates out after tax interest expense as follows:
Return On Assets (ROA) = ((Net Income + Interest Expense)/ (Total Assets) x 100
What Makes the Best Return On Assets (ROA) Ratio?
The best ROA ratio often viewed simplistically as the highest positive percentage. Investors will however need to look at other investment ratios to gain a fuller understanding of the situation before investing any money. This is because a high ROA percentage implies that a company is profitable. Other factors such as risk must also be considered by the investor.
An Alternative to the ROA Calculation is the Return On Net Assets Calculation
The Return On Net Assets ratio is an adaptation of the ROA ratio. It can be defined as follows:
Return On Net Assets (RONA) = ((Net Income) / (Fixed Assets + Working Capital)) x 100
This helps remove items such as long-term liabilities, since they may be deemed less appropriate for certain investor decisions.
What are the Issues With the Return On Assets Ratio Analysis of a Company?
Often the following are perceived as ROA issues by potential investors:
- The valuation of the Total Assets is a snapshot taken on one particular day. The investor needs to look at the Total Assets trends.
- It is difficult to look at this ROA ratio by itself; it is of greater value to the investor when compared to other financial ratios. The Return On Assets ratio is also of better investor value when the expectations of the industry ROA, in which the company is operating, is known to the investor.
- Some investors consider the ROA ratio more useful when applied to investor assessments of manufacturing firms, whereas investors sometimes perceive the ROA ratio of less value to service firm assessments.