Which of the following is true regarding Return on Assets (ROA)?

• A. ROA measures how efficiently a company uses its assets to generate net income.
• B. A higher ROA always indicates higher financial leverage.
• C. ROA is only relevant for service-based companies.
• D. ROA is calculated by dividing total liabilities by total assets.

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 a key indicator of profitability and operational efficiency.
2. Clarify the formula for ROA: ROA is calculated using the formula: $\frac{\mathrm{Net Income}}{\mathrm{Total Assets}}$. This formula shows the relationship between net income and total assets.
3. Evaluate the statement 'A higher ROA always indicates higher financial leverage': This is incorrect because ROA measures operational efficiency, not financial leverage. Financial leverage is related to the use of debt in financing, not asset efficiency.
4. Assess the statement 'ROA is only relevant for service-based companies': This is incorrect because ROA is relevant for all types of companies, including manufacturing, retail, and service-based companies, as it measures overall asset efficiency.
5. Analyze the statement 'ROA is calculated by dividing total liabilities by total assets': This is incorrect because dividing total liabilities by total assets calculates the debt ratio, not ROA. ROA specifically uses net income and total assets in its formula.