It's useful for an investor to learn how to calculate a financial ratio known as "return on assets" (ROA). This is a management-performance ratio that is generally used to compare different companies and the uses of their assets.
ROA is best used as a general reference over multiple time periods. It can observe management's use of the assets within a business to generate income. Knowing how to find the ROA will help you when you are examining a company's balance sheet and income statements. You can use the ROA as an indicator of value.
Return on Assets Formulas
The standard method of finding the ROA is to compare the net profits to the total assets of a company at a certain 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 find ROA. In most cases, these are line items on the income statement and balance sheet. With 2019 filings from Best Buy Co., we can use this formula to find the company's ROA. Page 109 of its annual report has the ROA calculated for the prior seven years.
ROA = $1.464 billion ÷ $12.994 billion
ROA = .113, or 11.3%
Generally, public companies report their net profits, or earnings, on their income statement and their total assets on their balance sheet a few times each year: annually, quarterly, and monthly. If you are looking for numbers 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 length of time in question rather than at one point in time.
ROA = Net Profit ÷ Average Assets
Keep in mind that a company's assets can fluctuate suddenly. For instance, this might happen if the company decides to sell several large pieces of equipment. For that reason, using the average assets to calculate ROA is often a better measure.
Return on Operating Assets
Another standard measurement of assets and the returns they produce is known as the "return on operating assets" (ROOA). It is similar to ROA in that it measures the return on assets. But ROOA measures the return on assets that are actually in use.
You calculate the ROOA by subtracting the value of the assets not in use from the value of the total assets, and 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 money, but they will often hold some assets in reserve to reduce spending during the next upward swing in demand. ROOA takes into account that all assets 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.
The Importance of Return on Assets
ROA allows you to see how much after-expense profit a company produced for each dollar in assets. In other words, ROA measures a company’s net earnings in relation to all the resources at its disposal.
ROOA measures the efficiency of assets that are being used. These measurements are indicators of management's efficiency with asset use. This is a key profitability metric. It's meant to give investors insights into shareholder revenue generation.
A higher ROA is often thought to be better than a lower ROA. However, you should be careful when using this ratio. ROAs cannot be compared across industries. Sometimes, they cannot even be used to compare businesses in the same industry, 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 a good idea to look back at these ratios often. They can change a lot over time, based on business performance and asset use.