What is a Return on Asset (ROA)?

Return on asset (ROA) is a financial ratio that measures how profitable an organisation is in relation to its total assets.
Businesses need to know how much their investments are paying off, which is why return on investment (ROI) is such a common tool used to compare profits to revenue. Unfortunately, those comparisons do not always tell the full story of a company’s finances or overall efficiency. This is why companies use ROA, a subtype of return on investment (ROI).  
ROA provides a more accurate picture of the organisation’s overall profitability, rather than simply looking at the impact of their investments. Leveraging ROA calculations can help businesses understand how well the company is using assets to make a profit, which is essential to corporate leadership, investors and analysts who must make large-scale decisions about the company’s direction and resources.

A business can glean some useful information using ROI about their operations, but to understand how proficiently a company can produce and function, profits must be assessed based on a company’s net worth, not just revenue. ROA is a measurement that indicates the efficiency of net earnings made using invested capital or assets, which is especially useful for planning future investments and resource allocation.

To put it simply, your ROA illustrates how well or how poorly your company uses its owned assets, including tangible assets like machinery and vehicles to intellectual property. It is far more difficult to measure your business’ performance with just your annual revenue, which is why analysts particularly benefit from ROA when calculating a company’s profitability over several quarters or even years. Companies also use ROA to compare their profitability to competitors in the same industry, which can tell you a lot about your business’ efficiency.

ROA is a ratio, and it is most often presented as a percentage. To calculate your return on assets, you need two main values: your net income and your average total assets. You get your ROA by dividing that net income by the company’s average total assets and then multiplying that result by 100 to get the percentage.
Graphic outlining how to calculate ROA

The formula looks like this:

ROA = Net income/Average total assets 

Net income can be calculated by subtracting the cost of goods sold and your expenses from your total revenue.

Average total assets should include all assets on your balance sheet at the end of the current year plus the total assets at the end of the previous year, divided by two (to get the average). You use the average total assets because your asset total fluctuates over time as you make purchases, deal with inventory changes, seasonal sales etc. Using an average over a set period can give you a much better idea of your ROA.

As an example, consider this comparison: Say there are two small companies—Company A that buys the absolute bare minimum assets to get started, and Company B that spends more on the bells and whistles. Company A’s average total assets are about $5,000 while Company B spends $10,000.

Now say that Company A makes $500 over a set period and Company B brings in $8000 over the same period. Company B has generated more revenue and has a ROA of 8%, but Company A has a higher ROA of 10%.  

Company A: 10% = $500 (x100) $5,000

Company B: 8% = $800 (x100) $10,000 

ROA isn’t the end-all-be-all for your business and ROI is likewise a principal factor in your finances. That said, a better ROA suggests that a company is using its assets and funds wisely. A low ROA is more common with companies that have more assets that generate profit while companies with a higher ROA have fewer assets.

Generally speaking, a ROA of 5% or lower would be classified as a low ROA and a high ROA would be 20% or higher. Often, a good benchmark for ROA is 5% or higher and anything over 20% is excellent. Still, a “good” ROA is going to vary based on the individual company, the time frame used during calculations and several other factors—ROA does give you important insights, but you must take the context of your business and other elements into account.

The best way to gauge your ROA results is by looking at industry standards and comparing your company’s ROA to your competitors. Some industries naturally require more assets while others don’t have to spend nearly as much on those resources.  

For example, a large construction company likely has many expensive assets (vehicles, digital devices, machinery etc.). A small business owner who owns a taco stand is not going to have the same assets because they are a light-asset company. It would be inappropriate to compare the two ROAs. Additionally, other factors such as seasonality may affect annual ROAs differently for certain industries.

The construction company may have a ROA of 7% while the taco stand has one of 15%, but what does that really tell you about either company? It would be more effective for the construction company to look at what other construction businesses have for ROA and see how their business measures up. If most construction companies fall between 5% and 9%, then a 7% ROA is competitive.

Return on assets and return on equity (ROE) measure how effectively a company uses its resources, but they are not the same—especially when it comes to debt. ROA considers all assets, including potential liabilities such as the debt a company borrows to run its operations. This tells you how well your assets are generating profits.

On the other hand, ROE shows you how well your company is managing the money you have invested with shareholders to generate profits. In this regard, ROE is solely focused on equity, which means ROE is not factoring in liabilities. The more leverage and debt a company acquires, the higher the ROE will be relative to ROA. So, the more debt you have, the more your ROE will exceed your ROA.

ROA is key to understanding your profitability as a company, but it is not the only measurement that matters, nor is it useful in every scenario. As discussed, one of the biggest limitations of ROA is that it cannot be used across industries due to different industries having various asset bases.

Plus, ROA is not the only tool you can use to analyse your company’s efficiency and overall financial performance. The current economy and market conditions, the seasonal disruptions of your industry, and the fluctuations in your assets themselves can complicate your ROA results.

There is also the matter of the ROA formula and how it incorporates debt and equity. The “total assets” in the ROA equation include both debt and equity investors, whereas the “net income” is only comparing returns to equity investors. So, variations of the ROA formula consider the inconsistency by putting interest expense back into your net income. The formula variations look like this:

Variation 1: ROA = Net income + [interest expense x (1-tax rate)] Total assets 

Variation 2: ROA = Operating income x (1-tax rate) Total assets

Despite some of the limitations of ROA, there are tools and technologies available to businesses that can streamline asset management and optimise your asset investments.

For example, IT asset management (ITAM) and enterprise asset management (EAM) tools help you better utilise your business assets by ensuring those assets are being used and cared for properly. This technology helps you guarantee that your devices or vehicles are being deployed when they should be, or that repairs and preventative maintenance to your machinery happen on time. You can more closely monitor your inventory stocks to make sure your assets don’t waste away on a shelf and avoid loss and theft. These tools also store all kinds of asset data points so you can make informed purchasing decisions in the future.

Ultimately, ITAM and EAM platforms automate asset management so that you can have more visibility on your resources, reduce costs and minimise risks, and leverage the benefits of the modern cloud infrastructure. You can track asset goals and enjoy all kinds of metrics that help you align your assets with your business objectives. If you want to take your asset management to the next level, boost your ROA along with the rest of your financial health, and simplify your decision-making, an asset management tool is the resource you need.

ServiceNow offers high-end asset management tools that are user-friendly and comprehensive for the needs of your business. No matter the size of your company or your asset base, our tools are designed to keep up with your pace and workload. Get a free demo with ServiceNow today to try our ITAM platform!

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