How to Calculate Return on Assets (ROA)
It's useful for investors to learn how to calculate a financial ratio known as return on assets (ROA). This is a management performance ratio generally used by investors to compare different companies and the uses of their assets. It is also best used as a general reference over multiple time periods to observe management's use of the assets within a business to generate income.
It is important to understand how to calculate the ROA so that when you examine a company's balance sheet and income statements, you are able to quickly use the ROA as an indicator of value.
Return on Assets Formulas
The standard method of determining the ROA is to compare the net profits to the total assets of a company at a specific point in time:
ROA = Net Profits ÷ Total Assets
The first formula requires you to enter the net profits and total assets of a company before you can calculate ROA (generally, these are line items on the income statement and balance sheet). With 2019 filings from Best Buy Co., we can use this formula to discern its ROA (page 109 of its annual report has the ROA calculated for the last seven years).
ROA = $1.464 billion ÷ $12.994 billion
ROA = .113, or 11.3%
Generally, public companies report their net profits (earnings) on their income statement and their total assets on their balance sheet annually, quarterly, and monthly. If you are looking for measurements throughout a period instead of at annual reporting time, use the average asset method to calculate the ROA. Simply take the average of the assets over the period in question instead of at one point in time.
ROA = Net Profit ÷ Average Assets
Because a company's assets can fluctuate suddenly—for instance, if the company sells several large pieces of equipment—this method of using the average assets to calculate ROA is generally more accurate.
Return on Operating Assets
Another standard measurement of assets and the returns they generate is the return on operating assets (ROOA). ROOA is similar to ROA in that it measures the return on assets, but ROOA measures the return on assets that are actually in use.
ROOA can be calculated by subtracting the value of the assets not in use from the value of the total assets, then dividing the net income by the result.
ROOA = Net Income ÷ ( Total Assets - Assets Not in Use )
Companies that endure tend to follow the upward and downward swings of the business cycle, where supply and demand fluctuate in an attempt to stabilize. When demand is rising, companies will increase the number of assets they use to produce their goods and services.
When demand is reduced, most companies will sell assets to recoup some capital but will hold some assets in reserve to reduce the expenditures during the next upward swing in demand. This ratio takes into account that all assets in a company are not typically being used at any given time.
With this in mind, ROOA is a much more accurate measure of how assets are being used to generate income.
Importance of Return on Assets
ROA lets an investor see how much after-expense profit a company generated for each dollar in assets. In other words, ROA measures a company’s net earnings in relation to all the resources it had at its disposal. ROOA measures the efficiency of assets that are being used. These measurements are indicators of management's efficiency with asset use, a key profitability metric designed to give investors insights into shareholder revenue generation.
A higher ROA is generally considered better than a lower ROA. However, you should be cautious when using this ratio. ROAs cannot be compared across industries, and sometimes cannot be used to compare businesses in the same industry. This is because each business operates and manages its assets differently.
For ROA and ROOA to be effective comparison tools, businesses need to be very similar in structure and practice. It's also important to revisit these ratios often, as they can change significantly over time based on business performance and asset use.