The ROA (Return on Assets) index is among the most used balance sheet indicators: here is the meaning, formula and calculation example for use in analysis.
The ROA (Return on Assets) index represents one of the most significant indicators for evaluating the economic efficiency of a company, but not only that. This important financial analysis tool measures the company’s ability to generate profits through the use of its assets. Its relevance in the financial world derives from its ability to provide a clear vision of the company’s profitability in relation to the investments made.
In fact, for those who use fundamental analysis to choose which stock to invest in, it is customary to use profitability indicators. The Return on Assets (ROA) is part of that category of indicators that gives a potential investor an idea of whether or not it is worth investing in the chosen stock.
The ROA index is typically used as a comparison parameter with other indicators, such as the Return on Equity (ROE) or as an alternative to the Return on Investment (ROI). Here, in detail, is what ROA indicates and how (and why) it is used in investment choices.
What is ROA and what is it for
The Return on Assets (ROA) represents a fundamental indicator for measuring the efficiency of a company in generating profits through the use of its assets. This financial index expresses, in percentage terms, the company’s ability to obtain returns from the resources at its disposal.
The peculiarity of the ROA index lies in its ability to evaluate overall management efficiency, considering both equity and third-party capital. This aspect makes it particularly significant for various corporate stakeholders.
- Investors use it to identify companies that generate the best returns on invested capital.
- Financial analysts use it to evaluate financial health and growth trends.
- Company management uses it to identify operational areas that need improvement.
- Financiers consider it to evaluate the company’s ability to repay debt.
A crucial aspect of ROA is its variability between different industrial sectors. A manufacturing company, for example, will typically have a different ROA than a technology company, due to the different asset structures needed to operate. For this reason, the comparison is significant mainly between companies in the same sector.
Obviously, the higher the ROA the better: it means that the company is able to make the most of the resources at its disposal. Generally, however, the ROA must be at least higher than the interest rates offered by central banks, otherwise it would mean that the money borrowed by the company cost more than it then returned.
The relevance of ROA emerges particularly in the temporal analysis of company performance. An increasing trend indicates an improvement in productivity and management efficiency, while a decreasing trend may signal the need to optimize the use of assets or reconsider investment strategies.
How to calculate ROA: the reference formulas
Calculating ROA is very simple: just divide the profit before financial charges (some also use net profit) by the total assets (or Assets), deductible from the balance sheet.
Here is the basic formula:
- ROA = Net Profit ÷ Total Assets
To obtain a more accurate calculation, it is advisable to use the average of the total assets, considering both the initial and final value of the period in question. The formula for calculating the average of assets is:
- Average Total Assets = (Beginning Assets + Final Assets) ÷ 2
There are two main variants of the ROA formula that take into account interest expenses and taxes:
| Variant | Formula |
| Variant 1 | ROA = [Net Profit + (Interest Expense × (1 - Tax Rate))] ÷ Total Assets |
| Variant 2 | ROA = [Operating Income × (1 - Tax Rate)] ÷ Total Assets |
For the practical calculation of ROA, it is necessary to consider the following elements:
- Net Profit comes from the income statement;
- Total Assets are found in the Balance Sheet;
- Average Assets balances out temporal variations;
- Tax rate depends on the applicable tax regime.
ROA valid when used together with ROE
ROA can be used to make a comparison between companies in the same sector, even better if accompanied by ROE or ROI. A retail investor will be more interested in using ROE and ROA in tandem, since the former expresses the ability of the company in question to create value for shareholders.
High ROE values are already a good reason in themselves to focus on the study of a company but there is the risk of being deceived by one aspect.
ROE does not take into account levels of indebtedness but, on the contrary, tends to increase as liabilities increase. This is because the denominator of ROE contains net equity, which is the difference between assets and liabilities. If the latter increase, the denominator will decrease and consequently give a bullish push to ROE.
The ROA instead takes into account the debt since the total assets, i.e. the denominator of the ROA, is given by the sum of the assets and the liabilities. Consequently, if the liabilities increase, the denominator also increases, consequently decreasing the total value of the ROA.
This is why it is a good idea to compare the ROE with the ROA of a company and with those in the same sector: obviously an investor will prefer the company that has historically given the best performance in terms of both ROE and ROA.
ROA: the 5 key points to remember
In conclusion, we can therefore affirm that the ROA is a very useful tool for evaluating an investment. To recap, the following must be kept in mind:
- the higher the ROA, the better;
- it is a good idea to compare the ROE or the ROI with the ROA;
- the ROA can be compared with that of similar companies;
- it is better to look at the historical performance of the ROA of the company under study;
- the ROA must be at least higher than the interest rates offered by the central bank of the country where the company is based.
Original article published on Money.it Italy. Original title: Indice ROA (Return on Assets), formula e guida per il calcolo
