what is a good return on assets ratio

Striving for sales growth often means major upfront investments in assets, including accounts receivables, inventories, production equipment, and facilities. A decline in demand can leave an organization high and dry and over-invested in is accounts receivable considered an asset assets it cannot sell to pay its bills. In closing, the return on assets (ROA) metric is a practical method for investors to grasp a better understanding of how efficient a company is at converting its asset purchases into net income.

What Return on Assets (ROA) Means to Investors

Net income is the net amount realized by a firm after deducting all the costs of doing business in a given period. It includes all interest paid on debt, income tax due to the government, and all operational and non-operational expenses. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. https://www.quick-bookkeeping.net/comprehensive-income/ Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. A “good” ROA depends on the company, the time frame of the calculation, and a few other factors. “Better than your competition is what I’d aim for. Generally, you would compare competitive companies or industries.”

what is a good return on assets ratio

Balance Sheet Assumptions

Since company assets’ sole purpose is to generate revenues and produce profits, this ratio helps both management and investors see how well the company can convert its investments in assets into profits. You can look at ROA as a return on investment for the company since capital assets are often the biggest investment for most companies. In this case, the company invests money into capital assets and the return is measured in profits. For example, banks tend to have a large number of total assets in the form of loans and investments. A large bank might have $2 trillion in assets and generate similar net income to an unrelated company in another industry.

  1. The average assets held is calculated by adding the amount of assets a company had at the beginning of the measuring period with the total assets at the end, then dividing by two.
  2. The relationship between return on assets (ROA) and return on equity (ROE) is directly related to the topic of debt financing, i.e. the reliance on leverage in the capital structure.
  3. To factor this into your calculation, use the average value of assets the company owned in a given year, rather than the total value of its assets at year end.

Return on assets formula

“ROA is used by investors to see how a company’s profitability, relative to its assets, has changed over time and how it compares to its peers,” says Michelle Katzen, managing director at HCR Wealth Advisors. “The ROA is one indicator that expresses a company’s ability to generate money from its assets.” If return on assets (ROA) uses average assets, then ROA and ROAA does my small business need an accountant or a bookkeeper will be identical. An analyst will take the asset balance from the firm’s balance sheet at the end of Year 1, and average it with the assets at the end of Year 2 for the ROAA calculation. The ROAA result varies greatly depending on the type of industry, and companies that invest a large amount of money up front into equipment and other assets will have a lower ROAA.

ROA Formula / Return on Assets Calculation

By knowing what’s typical in the company’s industry, investors can determine whether or not a company is performing up to par. However, in the “Downside Case”, the company’s return on assets (ROA) declines https://www.quick-bookkeeping.net/ from 8.5% in Year 1 down to 6.1% – with the opposite changes (and implications) on the balance sheet and income statement. A rising ROA may indicate a company is generating more profit versus total assets.

Companies with rising ROAs tend to increase their profits, while those with declining ROAs might be struggling financially due to poor investment decisions. For instance, a software maker has far fewer assets on the balance sheet than a car maker. As a result, the software company’s assets will be understated and its ROA may get a questionable boost. Every dollar that Macy’s invested in assets generated 8.3 cents of net income. Macy’s was better at converting its investment into profits, compared with Kohl’s and Dillard’s. One of management’s most important jobs is to make wise choices in allocating its resources, and it appears Macy’s management, in the reported period, was more adept than its two peers.

Generally, all companies should strive to maximize the output level with the required spending kept at a minimum – as this means the company is operating near full capacity and efficiency. Exxon’s ROA is more meaningful when compared to other companies within the same industry. “The values can differ if the formula is changed,” says Adam Lynch, senior quantitative analyst at Schwab Equity Ratings. “Often these alternate versions vary the unit of time used in the calculation.” For starters, the “return” numerator of net income is suspect (as always), given the deficiencies of accrual-based earnings and the use of managed earnings. This also helps clarify the different strategic paths companies may pursue—whether to become a low-margin, high-volume producer or a high-margin, low-volume competitor.

You can see that ROA gives a quick indication of whether the business is continuing to earn an increasing profit on each dollar of investment. Investors expect that good management will strive to increase the ROA—to extract a greater profit from every dollar of assets at its disposal. The return on assets ratio measures how effectively a company can earn a return on its investment in assets. In other words, ROA shows how efficiently a company can convert the money used to purchase assets into net income or profits. Return on Assets (ROA) is an important metric for gauging the profitability of a company. However, it is not the only relevant metric, and investors should make sure to look at the full picture when they compare different companies.

Similarly, investors can weigh ROA against the company’s cost of capital to get a sense of realized returns on the company’s growth plans. A company that embarks on expansions or acquisitions that create shareholder value should achieve an ROA that exceeds the costs of capital. Moreover, it’s important that investors ask how a company’s ROA compares to those of its competitors and to the industry average.

If that sounds abstract, here’s how ROA might work at a hypothetical widget manufacturer. The company owns several manufacturing plants, plus the tools and machinery used to make widgets. Then there are its unique widget designs, and the cash and cash equivalents it keeps on hand for business expenses. The increase in PP&E sitting on the B/S can be interpreted as increased CapEx spending, which is often caused by lackluster growth and/or increased competition in the market.

Under the same time horizon, the “Total Assets” balance decreases from $270m to $262m. If the active case is set to “Upside”, the “Total Current Assets” increases from $150m in Year 1 to $158m by the end of Year 5. But besides comparisons to industry competitors, another use case of tracking ROA is for tracking changes in performance year-over-year. Click the link below and we’ll send you MarketBeat’s list of ten stocks that will drive in any economic environment. UnitedHealthcare showed a net income of $20.12 billion in the previous fiscal quarter.

The ROA metric is commonly expressed as a percentage using a company’s net income and its average assets. A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits while a lower ROA indicates there is room for improvement. A company can arrive at a high ROA either by boosting its profit margin or, more efficiently, by using its assets to increase sales. Investors can determine whether that ROA is driven by, say, a profit margin of 6% and asset turnover of four times, or a profit margin of 12% and an asset turnover of two times.

Analysts often use average assets because it takes into consideration balance fluctuations throughout the year and provides a more accurate measure of asset efficiency over a given time period. Though ROA is a helpful calculation, it’s not the only way to measure a company’s efficiency and financial health. A company’s ROA is influenced by a wide range of additional factors, from market conditions and demand to the fluctuating cost of assets that a company needs.