Ratios: Return on Assets (ROA) - Online Tutor, Practice Problems & Exam Prep

Ratios: Return on Assets (ROA)

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. This measures the income a company earns based on the amount of assets it has to maintain. So, you can imagine, it's better to earn the same amount of money using fewer assets than more assets, right? That should make sense. If we can make $1,000,000 using just $1,000,000 worth of assets, well, that sounds better than having to make that same $1,000,000 while holding $10,000,000 or $100,000,000 of assets, right? The fewer resources we need to make the same amount of money, the better, right? So, ROA, it's a common profitability ratio but it's also an efficiency ratio. How efficient are we with our assets? It kind of helps us measure both of those there. Alright? So, return on assets. We generally, you're gonna hear it as ROA. This very common acronym for return on assets is ROA. So, this is how we do it here. We've got net income in our numerator and average total assets in the denominator. 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 2. That's how we're always gonna do it for any average balance. Beginning balance plus ending balance divided by 2. Okay? And remember, not every question is going to give you a beginning and ending balance. If they just give you one balance, well, just use that number. If they don't give you two years of balance sheets that show you total assets last year, total assets this year, well, 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. So, remember, this is always gonna give you a decimal when you do your calculation here. So, multiply by 100, move the decimal place two places and you'll be in percentage mode. Alright? So let's go ahead and discuss how do we analyze a return on assets ratio. 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, how much net income do we get out of that? Okay. Different industries, you can imagine, are going to have different return on assets. There's going to 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 going to have tons of assets. Whereas, there might be companies that have way fewer assets; a lot of tech companies might not have to have tons of assets to make their money. So, you're going to have to compare when you do this. We're going to use, like we've done with a lot of ratios, what's called benchmarking. So, we want to compare to our competitors and see how our ROA compares to our competitors or an 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 going to get a negative ROA, 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. So, negative ROA, 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 ROA. 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 ROA. Cool? Let's do that now.

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?

• A. 8%
• B. 10%
• C. 13%
• D. 63%

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?

• A. 6.7%
• B. 11.1%
• C. 33.3%
• D. 44.4%