Investments are measured based on their return or return potential. The return for an asset is measured in many different ways. In general, the return is the calculated by dividing the profit from the investment by the cost of the investment. This is also the case for return on assets.
Return On Assets
Return On Assets is calculated by dividing company earnings or net income by the value of assets. Net income is found at the bottom of the income statement which is in the annual report. Total asset value is found on the balance sheet which can also be found within the annual report. ROA is used as a way to measure management's ability to make a profit from the company's assets.
As an example, assume a company has $100,000 in net income at the end of the year. Since the balance sheet is a snapshot of company assets, analysts must take an average of total assets from two consecutive years for the calculation. If the company has $1 million in assets in Year 1 and $2 million in Year 2, the average is $1.5 million. ROA is calculated by dividing $100,000 by $1.5 million. This number is then multiplied by 100 for a percentage.
One advantage of the ROA calculation is the ease with which investors can interpret results. Following the example above, the ROA is equal to 6.7 percent. This tells the analyst or investor that management can make .067 cents on every dollar of assets invested with the company. The higher the ROA, the more efficient management is at managing and using company assets.
Another advantage of using ROA is that it can be easily compared against the ROA for other companies in the same industry. In general, companies with a high degree of assets in capital intensive industries, such as steel or utilities, will have a lower return on assets since they are forced to purchase such expensive assets in order to operate and vice versa.