Return on assets is a profitability ratio that provides how much profit company can generate from its assets. In other words, the return on assets (roa) measures how effectively the management of the company in generating income from economic resources or assets on their balance sheets. ROA is displayed as a percentage, and the higher the number, the more efficient the management of the company in the management of its balance sheet for profit.
Calculation of return on assets (roa)
The formula for ROA is:
Net profit or income, which is at the bottom of the statement of profit or loss used as the numerator. Net income is the amount of total revenue that remains after accounting for all production costs, overhead operations, administration, debt service, taxes, depreciation and wear, and also for one-time expenses for unusual events such as lawsuits or major purchases. Net profit also accounts for any additional income not directly related to primary operations such as investment income or one-time payments for the sale of equipment or other assets.
Average total assets are taken in the calculation of ROA, because of the company’s assets may vary over time due to the buying or selling of vehicles, land or equipment, inventory changes, or seasonal fluctuations in sales. The calculation of total assets over the period is more accurate than total assets for the same period. The company’s total assets can easily be found on the balance sheet.
Corporation “Exxon Mobil” (SOM)
Presented below is the balance sheet from the 10K statement Exxon shows 2017 and 2016 of total assets (highlighted in blue).
- In total assets for 2017 totaled $349 billion (rounded).
- In total assets for 2016 amounted to $330 billion (rounded).
- Exxon, total average of assets = $339.5 ((349 + 330)/2)
Below is the income statement for 2017 for Exxon on their application 10K.
- Exxon reported net income of $19.7 bn in 2017.
- ROA Exxon = ÷ 19.7 billion 339,5 billion $ = 5.8%
- This means that for every dollar of assets in 2017, “Exxon” earned 5.8 cents in profit.
ROA Exxon is more important in comparison with other companies in the same industry.
Here are 2017, ROAs for comparable companies:
- Chevron Corp. (cvx) ROA = 3.57%
- “British petroleum” (BP) ROA = 1.26%
Comparing ROA Exxon with industry peers, we see that Exxon generates more profit for every dollar of assets than Chevron or BP.
Calculation of ROA of the company can be useful when comparing the profitability of the company for several quarters and years as well as in comparison with similar companies.
However, it is important to compare with similar size and industry. For example, banks usually have large number of assets on their books in the form of loans, funds, and investments. A large Bank can easily have more than $2 trillion in assets as net income, which is similar to enterprises in other sectors. Although the Bank’s net income or profit can be an independent company and the Bank may have a high asset quality, ROA will be lower. A greater number of total assets is divided by net income, creating a Lower ROA for the Bank.
Similarly, the automobile production requires huge capacities and specialized equipment. Profitable software company, which sells downloadable programs Online can generate the same amount of profit, but it can be much higher the ROA, the more asset-heavy peers. When using this metric to compare productivity in different organizations, it is important to consider what types of assets required for operation in the industry, and not just compare numbers.