## 2.2. Return on assets (ROA)

Return on assets (ROA) shows how effectively a company utilizes assets available to generate profits. This ratio is calculated by dividing net profit before taxes by total assets. In other words, return on assets shows how much profit is generated with every dollar invested in the company’s assets.

A low return on assets ratio indicates that the effectiveness of utilizing a company’s assets is low, and on the contrary, a high return on assets ratio signals a highly efficient use of the company’s assets. Return on assets varies depending on the industry, and therefore, it is usually preferred to compare return on asset ratios for companies within the same or similar industry.

Return on Assets (ROA) Formula

Return on assets (ROA) is calculated by dividing net profit before taxes by total assets:

 Return on Assets (ROA) = Net Profit before Taxes x 100% Total Assets

Net profit before taxes measures the company's operating and non-operating profits before taxes. It is the same as the profit before taxes.

Total assets are the economic resources a business uses to accomplish its main goal (i.e., increase the owners' wealth).

Sometimes average assets are utilized as the denominator in the return on assets formula instead of total assets. Average assets can be calculated by adding total assets at the beginning of a period to total assets at the end of the period and dividing the result by two.

 Return on Assets (ROA) = Net Profit before Taxes x 100% Average Total Assets

Return on Assets (ROA) Example

In our example of Friends Company, to determine its return on assets, we will use the consolidated income statements and balance sheets available at the end of this tutorial. The return on assets for fiscal year 20X9 is calculated as follows (note: we are using the average assets in the formula):

 Return on Assets = \$4,220 x 100% = 15.9% (rounded) (\$26,150 + \$26,870) ÷ 2

The result shows that the company generated 15.9 cents of profit for every dollar in average total assets.

Important Notes

The following factors should be taken into account when evaluating the return on assets ratio:

• Using net profit (instead of net profit before taxes) will normally decrease the return on assets ratio.
• Return on assets ratio can be considered a measure of asset intensity. Examples of high asset-intensive industries are those in metallurgical, shipbuilding, car or plane manufacturing, railroads, and telecommunication. Examples of low asset-intensive companies are advertising agencies, accounting or consulting companies. Normally, return on assets ratios are higher in low asset-intensive industries and lower in high asset-intensive industries.
• Investors are usually interested in companies with higher returns on assets within an industry.
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