What Does Return on Assets (ROA) Mean?
Return on assets (ROA), also referred to as return on total assets or return on investment (ROI), is a ratio that measures how a company increases net profit by making the most out of its assets. This is done by dividing a company’s net income over the average of its total assets as represented in the following formula:
Return on Assets = Net Income / Average Total Assets
Divestopedia Explains Return on Assets (ROA)
Return on assets shows how much a company has maximized its assets in order to achieve its earnings. In essence, it measures the profitability of the assets of a given company. The higher the ROA, the better the company manages its assets.
This profitability ratio is important because investors sometimes look at the ROA of a company to determine if the company is successful enough at managing its assets, which can indicate if it is a good investment or not. This information proves useful when a company decides to do an IPO or simply issue shares to potential investors.
For example, a soap company called Suds Inc. began its fiscal year with $10,000,000 in assets. Throughout the year, the company expanded it operations and ended the year with $30,000,000 in assets. The company showed a net income of $5,000,000 during that given period. So, using the ROA formula:
$5,000,000 / [($10,000,000 + $30,000,000) / 2] = 25%
This result indicates that Suds Inc. earned a return of 25% or $1 of earnings for every $4 dollars invested in its assets. Potential investors can compare this ROA to that of other companies in the same industry to determine how Suds Inc. measures up in regards to properly managing its assets.