The Return on Assets (ROA) ratio describes how well a company uses its total assets to make a profit. The ratio is a great indicator of a company’s efficiency, as a higher number indicates that a company is generating a higher profit relative to its total assets. The formula is simple, as it compares net income to total assets:
Net Income
ROA = -------------------
Total Assets
A company’s ROA is highly dependent on its industry, so when using ROA as a comparative measure, it is most useful to compare a company’s ROA against its own historical ROA numbers or to compare it against the ROA from another company in the same industry. A higher ROA number is better, as it implies that the company is earning more money with fewer assets. If a company’s ROA is low, it means that the company is not using its assets to bring in enough income. For example, if company A has a net income of $2 million and total assets of $10 million, it has an ROA of 20%. If company B has a net income of $1 million and total assets of $10 million, it has an ROA of 10%. So, it is clear that company A has a higher ROA. Company A is using its $10 million worth of assets more efficiently, as it is making two times more income than company B, even though it spends the same amount on assets.
ROA is extremely important in judging a company, as you should invest in a company that spends its money wisely on its assets and knows how to use its assets efficiently. A company that can make two times more income from the same amount of assets clearly understands how to allocate resources and knows how to make large profits from little investments. While a company’s ROA should not be the only factor that you consider when doing research on a company you are thinking about investing in, this crucial ratio should definitely make a difference in your final decision.
Niki Pezeshki
College Trillionaire
Posts
No comments:
Post a Comment