9/6/2019 Return on Assets—ROA Definition

CORPORATE FINANCE & ACCOUNTING FINANCIAL RATIOS

Return on Assets—ROA
REVIEWED BY MARSHALL HARGRAVE | Updated Jul 3, 2019

TABLE OF CONTENTS
What Is Return on Assets—ROA? The Basics of Return on Assets—ROA
The Significance of ROA Example of Return on Assets—ROA
ROA vs Return on Equity—ROE Limitations of Return on Assets—ROA
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What Is Return on Assets—ROA?

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
ROA gives a manager, investor, or analyst an idea as to how efficient a company's management
is at using its assets to generate earnings. Return on assets is displayed as a percentage.

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KEY TAKEAWAYS
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Return on Assets (ROA) is an indicator of how well a company utilizes its assets, by
determining how profitable a company is relative to its total assets.
ROA is best used when comparing similar companies or comparing a company to its
previous performance.
ROA takes into account a company’s debt, unlike other metrics, such as Return on
Equity (ROE).

The Basics of Return on Assets—ROA

Businesses (at least the ones that survive) are ultimately about efficiency: squeezing the most
out of limited resources. Comparing profits to revenue is a useful operational metric, but
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out of limited resources. Comparing profits to revenue is a useful operational metric, but
comparing them to the resources a company used to earn them cuts to the very feasibility of

that company's’ existence. Return on assets (ROA) is the simplest of such corporate bang-for-
the-buck measures.

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ROA is calculated by dividing a company’s net income by total assets. As a formula, it would be
expressed as:

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Return on Assets = N et Income
T otal Assets

Higher ROA indicates more asset efficiency.

For example, pretend Spartan Sam and Fancy Fran both start hot dog stands. Sam spends
$1,500 on a bare-bones metal cart, while Fran spends $15,000 on a zombie apocalypse-themed
unit, complete with costume. Let's assume that those were the only assets each deployed. If
over some given time period Sam had earned $150 and Fran had earned $1,200, Fran would
have the more valuable business but Sam would have the more efficient one. Using the above
formula, we see Sam’s simplified ROA is $150/$1,500 = 10%, while Fran’s simplified ROA is
$1,200/$15,000 = 8%.

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9/6/2019 Return on Assets—ROA Definition

Return On Assets (ROA)

The Significance of Return on Assets—ROA

Return on assets (ROA), in basic terms, tells you what earnings were generated from invested
capital (assets). ROA for public companies can vary substantially and will be highly dependent
on the industry. This is why when using ROA as a comparative measure, it is best to compare it
against a company's previous ROA numbers or against a similar company's ROA.

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 is
earning more money on less investment.

Remember total assets is also the sum of its total liabilities and shareholder's equity. Both of
these types of financing are used to fund the operations of the company. Since a company's
assets are either funded by debt or equity, some analysts and investors disregard the cost of
acquiring the asset by adding back interest expense in the formula for ROA.

In other words, 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
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expense.

Example of How to Use Return on Assets—ROA

ROA is most useful for comparing companies in the same industry, as different industries use
assets differently. For example, 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 return on assets (ROA) for three companies in the retail industry:

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

The data in the table is for the trailing twelve months as of Feb. 13, 2019.

Company Net Income Total Assets ROA

Macy's $1.7 billion $20.4 billion 8.3%

Kohl's $996 million $14.1 billion 7.1%

Dillard's $243 million $3.9 billion 6.2%

Due to the increasing popularity of e-commerce, brick and mortar retail companies have taken a
hit in the level of profits they generate using their available assets. Still, every dollar that Macy's
has invested in assets generates 8.3 cents of net income. Macy's is better at converting its
investment into profits, compared with Kohl’s and Dillard’s. One of management's most
important jobs is to make wise choices in allocating its resources, and it appears Macy’s
management is more adept than its two peers.

Return on Assets—ROA vs Return on Equity—ROE

Both ROA and return on equity (ROE) are measures of how a company utilizes its resources.
Essentially, ROE only measures the return on a company’s equity, leaving out the liabilities.
Thus, 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.

Limitations of Return on Assets ROA

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Limitations of Return on Assets—ROA

The biggest issue with return on assets (ROA) is that it can't be used across industries. That’s
because companies in one industry—such as the technology industry—and another industry
like oil drillers will have different asset bases.

Some analysts also feel that the basic ROA formula is limited in its applications, being 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. Both interest expense and interest income
are already factored in.

Important: The St. Louis Federal Reserve provides data on US bank ROAs, which
have generally hovered around or just above 1% since 1984, the year collection
started.

For non-financial companies, debt and equity capital is strictly segregated, as are the returns to
each: interest expense is the return for debt providers; net income is the return for equity
investors. So the common ROA formula jumbles things up by comparing returns to equity
investors (net income) with assets funded by both debt and equity investors (total assets). Two
variations on this ROA formula fix this numerator-denominator inconsistency by putting interest
expense (net of taxes) back into the numerator. So 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

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Related Terms
LEARN MORE
Understanding Return on Average Assets
Return on average assets (ROAA) is an indicator used to assess the profitability of a firm's assets, and it is
most often used by banks and other financial institutions as a means to gauge financial performance.
more

Why Profitability Ratios Matter

Profitability ratios are a class of financial metrics used to assess a business's ability to generate profit
relative to items such as its revenue, operating costs, or balance sheet assets over time. more

After-Tax Return On Assets

After-Tax Return On Assets is a financial ratio that shows the percentage of after-tax income generated by
a company's investment in assets. more

Activity Ratios
Activity ratios measure a firm's ability to convert different accounts within its balance sheets into cash or
sales. more

How Return on Equity Works

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by
shareholders' equity. Because shareholders' equity is equal to a company’s assets minus its debt, ROE
could be thought of as the return on net assets. more

Understanding Return on Total Assets

Return on total assets is a ratio that measures a company's earnings before interest and taxes (EBIT)
against its total net assets. more

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9/6/2019 Return on Assets—ROA Definition

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