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.
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