Return on Assets (ROA): what is its importance and how to calculate it?
Do you know what ROA is for? Well, this acronym means Return on Assets. At first we can emphasize that it is a very important profitability indicator for an organization. Many people confuse it with ROI (Return on Investment). However, the two metrics have very different definitions.
The main difference between them is that, in the case of ROI, there is an analysis of parameters based on a given investment, whereas the ROA corresponds to the total asset of a business or investment portfolio of an investor. Therefore, we can see that the role of ROA is to demonstrate to managers what their real conditions are for generating profit based on the amount of assets they have. Even though it is an indicator of great need for financial control, many entrepreneurs are not fully aware of this topic.
To help in this matter, we have prepared this article to give you the main information regarding the return on assets. Read on and stay on top of it!
What is the importance of ROA?
ROA is a very important indicator for a corporation, as it shows investors how the company is actually behaving in terms of converting assets into net capital. As a result, it can be inferred that the higher the metric (given in percentage), the better it is for the business’s management.
More clearly, when a particular company has a low ROA index, there can be several causes that are generating the situation. One of them may be the targeting of projects and investments to relatively unprofitable areas. Another reason is linked to the low productivity of assets due to obsolescence or even very high waste and general expenses.
Thus, by taking this indicator into account, managers are able to evaluate internal results and identify and correct potential deficiencies within the company’s investments. Having a more precise understanding of these parameters makes achieving success with financial processes and turning the business into more profitable and sustainable easier.
How to calculate the ROA?
Calculating the ROA is quite simple and its data is easily located in the business’s financial statements. The procedure for finding it is similar to that for ROI. What distinguishes the two is that, in the case of the latter, it is necessary to divide the profit by the investment made, whereas for the ROA the profit amount is divided by the company’s total assets.
In a practical way, in order to find the value of this metric, the formula used is:
ROA = Operating Profit / Total Assets X 100
What care should I take when calculating ROA?
Even though it is a great profitability indicator, care must be taken when using it. This is because this parameter is based on total assets and does not take into account a factor known as intangible asset. Therefore, it is not recommended to use ROA when comparing two or more companies. It will only be efficient when used to make an internal comparison within the company, as is the case of evaluations of changes that occurred between one year and another within an institution.
Thus, these were the main information about the importance and how to calculate the Return on Assets of a company. We can see that this indicator plays a fundamental role within a company and, therefore, it should be measured constantly, making it possible to increasingly improve financial processes.
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