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ROA

 

ROA (Return on Assets) shows what profits are earned by company’s assets. Of course, assets alone usually do not earn the profit, because most of the times profit is the result of know-how and hard work of many employees. However, most of businesses require capital investments in to assets. Especially high investments are needed in heavy industry businesses, utilities and similar. The more capital is invested in to assets the higher profits are expected by investors from their investment. That’s why the ROA ratio was created – to show the profitability of the assets. 

 

Normal ROA should be from 10% to 15% percent. But of course, if businesses aren’t based on assets ROA may be much higher. If ROA is very high, it may indicate that this business if worth to receive more investments in to assets if there is potential to increase market share and sales maintaining the same profitability.

 

ROA is different ratio from ROE, because ‘assets’ include both capital groups: ‘shareholder’s equity’ and ‘debt capital’. That’s mean that ROA does not include the fact that net profit might be reduced by interest paid for borrowed capital, which is not really very fair. If you want to compare the return that is earned by assets (not equity), my suggestion (author’s note) would be to use EBIT instead of the ‘net income’ in ROA calculation. 

 

ROA calculation


Classical ROA formula

ROA = Net Profit / Total Assets


Formula recommended by Rokas Lukosius

ROA = EBIT* / Tangible assets**

 

* The reason why EBIT is used instead of Net Income is mentioned above. EBIT is equal to Pretax profit plus financial expenses minus financial income.


** Long-term assets are better to use than total assets, because working capital is very sensitive on management style, fluctuates a lot and do not represents profitability of the business’s assets. Also short term assets might be boosted for growth, with which ROA ratio do not has a lot in common. If assets are changing fast, better to average of the asset amount (at beginning and end of the fiscal year).


*** You may multiple the result by 100%.

Remember, if you will calculate ROA by this methodology, you should compare this ratio with ratios of other companies also calculated by the same methodology. And this methodology is better for comparison, but won't show the net return of the assets.

 

If you want to be even more exact, then you should calculate ROIC (return on invested capital) which uses NOPAT instead of EBIT or net profit.

 

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