Return on Assets ROA

What is ROA – Return on Assets?

Return on assets or ROA measures the percentage rate of return a business gets on its assets. It is calculated by dividing the operating income by the total assets of the business.

Formula for Return on Assets ROA

Return on assets = Operating income / Total assets
  • Operating income is shown in the income statement. It is sometimes referred to as earnings before interest and tax (EBIT) or profit before interest and tax (PBIT).
  • Assets is found in the balance sheet and includes long term assets and current assets. If available, it is better to use the average of the beginning and ending assets.

How to Calculate Rate of Return on Assets

Operating income from the income statement
Revenue 440,000
Cost of goods sold 176,000
Gross profit 264,000
Operating expenses 135,000
Depreciation 65,000
Operating income 64,000
Finance costs 20,000
Income before tax 44,000
Income tax expense 9,000
Net income 35,000

Assets from the balance sheet
Cash 5,000
Accounts receivable 125,000
Inventory 20,000
Current assets 150,000
Long term assets 390,000
Total assets 540,000
Accounts payable 90,000
Other liabilities 10,000
Current liabilities 100,000
Long-term debt 210,000
Total liabilities 310,000
Capital 60,000
Retained earnings 170,000
Total equity 230,000
Total liabilities and equity 540,000

In the example above the earnings before interest and tax is 64,000. The total assets are 540,000. The ROA return on assets is given by using the formula as follows:

Return on assets = Operating income / Assets
Return on assets = 64,000 / 540,000
Return on assets = 11.85%

Return on Assets (ROA) Interpretation

The return on assets is considered to be a fundamental financial ratio for a business. It measures the ability of a business to use its money to generate profits.

In this definition of return on assets interest is specifically excluded from the calculation by the use of operating income instead of net income. The amount of interest paid depends on the amount of debt and therefore the capital structure of the business, if interest was included it would distort the return on assets calculation and make it impossible to make comparisons with another business funded in a different manner. Of course depending on the comparison required, net income could alternatively be used instead of operating income, in which case the return would take into account the effect of capital structure.

Useful tips for Using the Return on Assets

  • The ROA (return on assets) will vary from industry to industry. To make comparisons you need to use an industry average return on assets for a comparable business operating in your sector.
  • The ROA (return on assets) will need to be higher than the return available if the same amount of money was invested in a minimal risk deposit with a bank.
  • ROA should always be higher than the rate at which the business borrows as an increase in borrowing leads to an increase in assets which in turn should give a higher return if the ROA is at the correct level.
Return on Assets ROA November 6th, 2016Team

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