As we all know, calculating financial ratios can be useful for investors. One of the financial ratios that the investor needs to calculate is the return of assets (ROA). ROA provides the underlying nature of a company that is different from return on Equity (ROE), hence here’s how to calculate it.
Why Is ROA Important?
Basically, asset turnover tells investors the total sales per dollar from the assets written on the balance sheet. Meanwhile, ROA, tells the investors how much after-tax profit generated by the company for each dollar in the asset.
ROA, in other words, measures the net earnings of a company in relation to its resources. that makes ROA becomes the most stringent test of return for shareholders.
If the company does not have debt, then, its return on assets and return on equity will be the same.
If an investor measures the ROA of a specific company over several year periods and monitors the changes, he or she will find things that happen in the business. The investor can find a warning of what will come in the future.
How to Calculate ROA?
There are two kinds of formula to calculate ROA
Formula 1: Net Profit Margin x Asset Turnover
Formula 2: Net Income / Average Assets for The Period
The first formula requires you two know the company’s net profit margin and asset turnover. Normally, you will have already had those two analyses when you reach ROA.
The second formula is much shorter than the first formula. You just need to divide the net income by the average asset during that period.
Asset Importance as a Business Measure
ROA is a way to know the asset intensity of a business. Lower profit per dollar of assets means the business has more intensive assets and vice versa.
With all things being equal, more intensive the asset from a business means there is more money that should be reinvested by the business in order for it to continuously gains income. That is a bad thing, wince company needs to continuously reinvest its asset.
The general rule is, ROA below 5% shows a very asset-intensive.
