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.