What is Return on Assets? How do you Calculate Return on Assets (ROA)?

Return on assets (ROA) is calculated by:

ROA equation

 

Return on Assets is usually represented as a percentage, and represents the Net Income the company was able to generate based on the amount of Assets it owns.

 

In other words, it tells potential investors the amount of money management is able to make with the assets that it has. The higher a company’s Return on Assets the better.

 

The figures needed to determine a company’s Return on Assets are found on the company’s balance sheet and income statement.

 

Below, we highlight the data on Intel’s 2012 10-k statement, which can be found here: http://www.sec.gov/Archives/edgar/data/50863/000119312513065416/d424446d10k.htm#toc424446_13

 

The Net Income is found near the bottom of the income statement:

Intel_2012_10k_Income_Statement-net-income

 

And the company’s total assets are found on the balance sheet: (Click to enlarge)

Intel_2012_10k_Balance_Sheet-Assets

 

Using the numbers from the images above, we can calculate Intel’s Return on Assets:

ROA equation for Intel

Or 13%.

 

This means that for every $10,000 invested into new assets for Intel, net income should increase by $1,300.

 

The higher the number the more money the company is able to make with the same amount of assets.

 

Use of Return on Assets (ROA) Analysis

 

To get a better idea of why return on assets is so important, consider two companies:

Company A has $1 million in Net Income.

Company B has $1 million in Net Income.

 

From this, both companies look to be the same.

 

However now consider:

Company A has a total of $10 million in Assets.

Company B has a total of $100 million in Assets.

 

Company A has a Return on Assets of 10%, while company by has a Return on Assets of only 1%.

 

This tells potential investors that the management of company A is more efficient in making money with its assets.

 

However it is important to note that when comparing the Return on Assets of different companies, ensure that the companies are in the same industry. A software company will have a significantly different return on assets than a railroad company.

 

Benefits Using Return on Assets:

 

Recall in our definition of Return on Equity (ROE):

“This means that as a company takes on more debt its liabilities increase, which reduces Shareholder Equity, which will increase ROE. Now obviously, if a company is taking on way too much debt that is not good… but its ROE number will look amazing.”

 

Return on equity does not take into account the company’s liabilities (debt), and therefore companies with high amounts of debt can lead investors astray in their fundamental analysis.

 

But Return on Assets takes into account a company’s liabilities. Recall the fundamental balance sheet equation:

 

Assets = Liabilities + Shareholder Equity.

 

As a company takes on more debt, let’s say in the form of a loan, its assets will also increase (because the company receives cash or other assets in exchange for the loan).

 

Therefore, Return on Assets also takes into account management’s ability to efficiently use its assets (such as equipment) along with financing (such as debt or bond issues).

 

For a company with no liabilities, its ROA and ROE numbers will be exactly the same.  Where the numbers start to diverge is when the company begins to take on debt.

Looking at ROA in combination with a company’s ROE can help tell a better story of the true efficiency of a company’s management. When ROE is very high, but ROA is very low it may be a sign that the company is not using its financing wisely.

 

Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports, Defines this as:

“Return on Assets.

The return on assets (ROA) ratio measures management’s success in employing the company’s assets to generate a profit.”