What does it mean when a company reports a Return on Assets (ROA) of 12\%?

• A. The company generates a net income equal to 12\% of its average total assets.
• B. The company has a profit margin of 12\% on its sales.
• C. The company earns a 12\% return on its shareholders' equity.
• D. The company pays 12\% of its assets as dividends to shareholders.

Answer: (A)

Verified step by step guidance

1. Understand the concept of Return on Assets (ROA): ROA is a financial ratio that measures how efficiently a company uses its assets to generate net income. It is calculated as Net Income divided by Average Total Assets, expressed as a percentage.
2. Clarify the meaning of a 12% ROA: A 12% ROA indicates that the company generates net income equal to 12% of its average total assets during the reporting period. This shows the company's efficiency in utilizing its assets to produce profits.
3. Eliminate incorrect interpretations: ROA does not represent profit margin on sales, return on shareholders' equity, or the percentage of assets paid as dividends. These are separate financial metrics (e.g., profit margin, return on equity, and dividend payout ratio).
4. Relate ROA to financial performance: A higher ROA generally indicates better asset utilization and profitability. It is a key indicator for investors and management to assess operational efficiency.
5. Summarize the correct interpretation: The correct answer is that the company generates a net income equal to 12% of its average total assets, as this aligns with the definition and calculation of ROA.