Return on assets (ROA) is a profitability formula companies use to calculate how much profit their assets produce. Investors often use ROA to determine how efficiently a company turns its assets into profits or net income. Companies and investors use two main formulas or variations of these formulas to calculate ROA.
Formula Number One
Investors often compare the ROA of different companies to determine which is the most profitable. The simplest formula for ROA is net income divided by total assets. For example, if company A has a net income of $100 and assets of $500, then the ROA is $100 / $500 = .20 or 20 percent. Assume Company B has $100 in net income and $500 in assets. ROA is then $100 / $400 = .25 or 25 percent. Company B generates 25 cents in revenue for every dollar it has invested in assets and is a more profitable investment than Company A.
Formula Number Two
Another ROA formula is net profit margin multiplied by asset turnover. The net profit margin is the profit companies make for every dollar in sales. Asset turnover is the amount of sales revenue the company generates for every dollar it has invested in assets. The formula for net profit margin is net income after taxes divided by revenue. The formula for asset turnovers is revenue divided by assets. This formula has three steps; first, net income after taxes / total revenue = net profit margin. Then, total revenue / assets = asset turnover. Finally, net profit margin x asset turnover = ROA.
Asset and Revenue Variations
One variation investors may use to calculate ROA is net income divided by the average assets for the period. In this variation, the investor averages the assets from two periods. For example, if a company has assets of $10 for one year and $15 for another year, the average assets for both years is: $10 + $15 = $25, then $25 / 2 = $12.50. Another variation of ROA is to add a company’s interest expense into net income. The formula for this variation is net income + interest expense / total assets = ROA.
Beginning and Ending Periods
Another variation of the ROA formula is net income / (assets at the beginning of a period + assets at the end of a period) / 2 = ROA. This formula is useful if a company is calculating ROA for the same period as opposed to comparing two different periods. For example, if a company wants to calculate the ROA for the current year, it would add the assets in January to the assets in December and divide that number by two to get the average assets for the year.
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