 ## Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

14. Financial Statement Analysis

# Ratios: Return on Assets (ROA)

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concept

## Ratios: Return on Assets (ROA) 3m
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Alright, let's discuss another ratio here. The return on assets. So return on assets is a really common ratio used and I would expect you to have to know it. So this measures the income a company earns. So we're gonna be talking about net income here based on the amount of assets it has to maintain. Right? So you can imagine, let's look at the second bullet, it's better to earn the same amount of money using less assets than more assets. Right? That should make sense. If we can make a million dollars using just a million dollars worth of assets. Well that sounds better than having to make to make that same million dollars to have to hold \$10 million of assets or \$100 million of assets. Right? The less stuff we need to make the same amount of money the better. Right? So our away it's a common profitability ratio but it's also an efficiency ratio. Right? How efficient are we with our assets? I'd say it kind of helps us measure both of those there. Alright, so return on assets, we generally, you're gonna hear it as R. O. A. This is a very common acronym for return on assets. Is that R. O. A. So this is how we do it here. We've got net income in our numerator and the denominator average total assets. Remember average whenever we've got an average amount in any of our ratios, Well we're gonna take the beginning balance of that amount and the ending balance and divide it by two. Right? So that's how we're always gonna do it for any average Balance beginning balance plus ending balance divided by two. Okay. And remember, not every question is going to give you a beginning and ending balance. If they just give you one balance, we'll just use that number right. If they don't give you two years of balance sheets that show you total assets last year, total assets this year, we'll just use the number they gave you. You don't have to calculate an average in this case. And one more note here with return on assets. Well, it's generally shown as a percentage. Right? So remember, this is always going to give you a decimal when you do your calculation here. So you multiply by 100. Move the decimal place two places and you'll be in percentage mode. Alright, so let's go ahead and let's discuss how do we analyze a return on assets ratio? So remember that this return on assets. What's it showing us? Well, it's showing us how much of the numerator for each unit of the denominator. So how much net income does the company get for each dollar of assets? Right. So for each dollar of assets we hold. Well, how much net income do we get out of that? Okay, so different industries you can imagine are gonna have different return on assets. There's gonna be some industries that are heavily reliant on having a lot of assets. Think of something like an airline industry right? Where they have to have airplanes that cost millions of dollars and they're gonna have tons of assets where there might be companies that have way less assets, A lot of tech companies might not have to have tons of assets to make their money. So you're gonna have to compare when you do this. We're gonna use like we've done with a lot of ratios. We use what's called benchmarking. So we want to compare to our competitors and see how our our R. O. A. Compares to our competitors or industry average. That's how we're going to really be able to tell how we're doing. Cool. So a red flag, the only way we're gonna get a negative R. O. A. Well, we couldn't have a negative denominator, right? There's no way to have negative assets, but we could have negative income. We could have a net loss, right? So a negative are away. Well, that lets us know that the company had a net loss and generally those aren't good things right? We want to be making money not losing money. So that's pretty much it for our away. It's not the most complicated ratio. So why don't we go ahead and just jump into some practice and you guys try and calculate some are okay, cool. Let's do that. Now
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Problem

XYZ Company had net sales during the period of \$380,000 and net income of \$60,000. If total assets were \$480,000 at the beginning of the period and \$720,000 at the end of the period, what is the company’s ROA?

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Problem

A company has income before taxes of \$100,000. Net sales are \$400,000 and gross profit is \$300,000. What is the ROA, assuming the company has a 40% tax rate, and average total assets were \$900,000? 