# Return on Assets - Explained

What is Return on Assets?

# What is Return on Assets?

Return on Assets or ROA measures the profitability of a business in relation to its overall assets. It allows a company to estimate how efficiently the assets of the company are being used for generating revenue. Return on Assets is a type of return on investments.

## How is Return on Assets Used?

A company's total assets is the sum of its total liabilities and shareholders equity. A company's operations are funded both by debt and equity. The assets of a company include cash and cash equivalent items, inventories, capital equipment as depreciated, and others. There are two approaches to compute the ROA of a company. It is either calculated as,

• ROA= Net Income/Average Total Assets

or

• ROA= (Net Income + Interest Expense) / Average Total Assets

Here, the net income is the total earning of a company in a particular period of time and the average total asset is the ending assets plus the beginning assets divided by 2. Net income on the income statement of a company does not include interest expenses, so the analysts may like to add the interest expense to the net income in order to ignore the cost of debt. In this second approach, the cost of acquiring the assets (debt) is negated. ROA is a ratio of the company's asset and its earning and it is represented as a percentage. For example, if a company's total earnings in a given period are \$ 20,000 and its average assets in that period equals \$100,000 then its ROA in that period is calculated as \$20,000/\$100,000= 0.2 or 20%. ROA is an indicator of the efficiency of a business in converting its investment into earning. Investors often compare the ROA of different companies in order to judge the viability of an investment. It is important to compare ROA of different companies operating in the same industry, as ROA may vary significantly from one industry to another. Typically, ROA for the companies operating in the service industry will be significantly higher than the ROA for the capital-intensive companies. A company may compare its ROA from different time periods to measure the business's performance. A higher ROA indicates the company has performed well as it signifies that they have earned more on less investment. It is the job of the management of a company to utilize their resources efficiently to earn more with less investment. ROA reflects that efficiency as a percentage or ratio. It is a quite simplistic approach to gauge the efficiency of a business and its management.

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