Return on assets, ROA, is an indicator of how a business manages existing assets when generating earnings. If ROA is low the management may be inefficient while a high ROA figure shows the business is running smoothly and efficiently.
Calculating the return on assets for a business
The ROA is normally expressed as a percentage figure. The calculation is arrived at by dividing the net income for the year by the total assets of the business. If a clothing store, for example, has a net income for the year of $1 million and total assets of $4 million then ROA would be:
($4 million) × 100 = 25%
By calculating the ROA the business will see where the return is on any investment and if the management is generating enough return from the assets available to them.
Management will look closely at the ROA figure at year end. If the ROA is high, it is a good sign that the business is making the most from what it already has in assets. Combing the ROA with the other metric, return on investment, may show that further investment is worthwhile and that the business is capable of using new investment efficiently.
Examining a low ROA is vital for the efficient running of a business. If the ROA is consistently low it may show that either management are not making enough use of existing assets or that assets within the business are of no longer any use. The clothing store may find that the same sales returns are possible from a smaller store area or that floor space could be better utilized in generating more sales.
A bank or potential investor will look at both the ROA and the ROI figures before extending credit facilities or embarking on further investment. If similar stores are generating higher figures they may look elsewhere or question why management are not getting the returns possible from the business.
Improving overall profit
The ROA figure can motivate management to make better use of assets. By seeing that the returns are not as they should be, they may make any necessary changes to their store. Also a ROA figure can show how improvements may be made to overall profit margin, by proper management of existing assets. This is always a better alternative to throwing more money at the store and hoping for the best.