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Return on Assets (ROA) Definition
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.
A Little More on What is Return on Assets
A company’s total assets is the sum of its total liabilities and shareholder’s 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
- 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.
References for Return on Assets
Academic Research on Return on Assets
Return on assets loss from situational and contingency misfits, Burton, R. M., Lauridsen, J., & Obel, B. (2002). Management science, 48(11), 1461-1485. This study creates a rule-based contingency misfit model and related hypotheses in an attempt to test the Burton and Obel (1998) multi contingency model for strategic organizational design. It also identifies and categorizes the misfits in the model using data derived from 224 small and medium Danish firms. This is because any misfit may significantly impact performance.
Modeling of banking profit via return–on–assets and return-on-equity, Petersen, M. A., & Schoeman, I. (2008, July). In Proceedings of the World Congress on Engineering (Vol. 2, pp. 1-6). This paper models bank profitability using return-on-assets (ROA) and return-on-equity (ROE) in a stochastic setting. Stochastic differential equations driven by the Levy processes are derived since they contain information regarding value processes of net profit after tax, equity capital and total assets and this information is essential in modeling the dynamics of the ROA and ROE.
Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against …, Heikal, M., Khaddafi, M., & Ummah, A. (2014). International Journal of Academic Research in Business and Social Sciences, 4(12), 101. This study attempts to analyze the effect of ROA, ROE, Net Profit Margin, Debt to Equity Ratio and Current ratio on the growing income partially or simultaneously on the automotive companies that were listed in Indonesia stock exchange. It also utilizes multiple linear regression and the classical assumption test to analyze the relationship between independent and dependent variables.
Working capital management and profitability: The relationship between the net trade cycle and return on assets, Erasmus, P. D. (2010). Management Dynamics: Journal of the Southern African Institute for Management Scientists, 19(1), 2-10. This research uses a sample of listed and delisted South African industrial firms to investigate the relationship between working capital management and form profitability. The results from the research suggest that management could try improving the profitability of a firm by decreasing the total investment in terms of net working capital.
What is your ROA? An investigation of the many formulas for calculating return on assets, Jewell, J. J., & Mankin, J. A. (2011). This paper performs a comparison of 11 different types of computing return on assets that can be found in the present business literature. It illustrates the differences between these versions by calculating every version of the ROA on eight different sample firms. The results are then analyzed and compared and the benefits and cons of each version discussed.
The impact of liquidity on Jordanian banks profitability through return on assets, Al Nimer, M., Warrad, L., & Al Omari, R. (2015). European Journal of Business and Management, 7(7), 229-232. This article presents a study aimed at determining whether liquidity through quick ratio has severe impacts on the profitability of Jordanian banks through return on asset. It revealed that there is a significant impact of the independent variable quick ratio on dependent variable ROA. This means that the liquidity through quick ratio significantly influences profitability through ROA in Jordanian banks.
Effect of return on assets (roa) against Tobin’s q: Studies in food and beverage company in Indonesia stock exchange years 2007-2011, Alghifari, S., Triharjono, S., & Juhaeni, Y. (2013). International Journal of Science and Research (IJSR), 2, 108-116. This is research carried out to determine the effect of ROA on the population of a food and beverage chain called Tobin’s Q that is listed in the Indonesia Stock Exchange. It uses purposive sampling method and analyzes the data using descriptive statistics and simple linear regression analysis. The results indicate that the ROA has significant impacts on Tobin’s Q.
Intangible asset deployment in technology-rich companies: how does innovation affect return on assets?, Arrow, A. K. (2002). International Journal of Technology Management, 24(4), 375-390. This paper attempts to identify the nature and fundamental cause of the continuous and systematic underutilization of technology in intangible assets worldwide. It also examines the effects of technology licensing on cash flow and why technology is used in shallow levels when compared to other cash-generating activities.
Determinant of return on assets and return on equity and its industry wise effects: Evidence from KSE (Karachi stock exchange), Mubin, M., Iqbal, A., & Hussain, A. (2014). Research Journal of Finance and Accounting, 5(15), 148-157. The primary purpose of this study is determining from the available components of Dupont identity Return on Equity, The component that is the most consistent or volatile among total assets turnover, profit margin and equity multiplier in various sectors. Preliminary results indicate that Assets turnover essentially varies between industries while Equity Multiplier and Profit margin are not so volatile across industries.
Measuring the economic rate of return on assets, Kapler, J. K. (2000). Review of Industrial Organization, 17(4), 457-463. This paper describes the process of correcting the deficiencies associated with the accounting rate of return and that of capitalizing intangible assets created by the R & D expenditures of a firm. The paper also shows the superiority of the derived measure of the rate of return in a fixed effects model that tests the relative influence of firm and industry impacts on yields.