ROA is one of the important financial indexes that helps investors evaluate the efficiency of using assets (capital) of a business or business project. So what is ROA? How to calculate ROA? How much ROA is good? Invite you to learn about ROA with Unich Analysis in the article below.
What is the ROA index?
ROA (Return On Assets) is the ratio of net profit to assets, often used to measure the profitability of a business’s total assets. Managers can use this index to evaluate the level of efficiency in business operations, thereby making decisions to improve or enhance business plans. Investors compare the ROA of different projects to make appropriate investment choices.
How to calculate ROA
ROA is calculated by the formula:
ROA = Lợi nhuận ròngTổng tài sản = Lợi nhuận ròngNợ phải trả + Vốn chủ sở hữu
In which:
- ROA is the ratio of net profit to assets.
- Net profit (net income) is the profit earned after deducting all expenses, including interest expenses, corporate income tax, and operating expenses. Operating expenses include cost of goods sold, general production costs, administrative and marketing expenses, and asset depreciation expenses. Net profit may include profits not directly generated from business activities such as the sale of assets.
- Total assets are all assets formed from equity and loans.
For example: A and B both run a bubble tea business. A spends 7 million VND to buy a cart, tools, and ingredients to make bubble tea. B spends 70 million VND to decorate a small space and buy tools and ingredients to make bubble tea. After 1 month, A earned a profit of 3 million VND, and B earned a profit of 15 million VND.
A’s ROA is 3/5 = 60%, B’s ROA is 15/70 = 21.4%. Thus, in the first month, A’s business is more effective than B’s because it has a higher return on assets.
Meaning of ROA index
ROA index shows the percentage of net income compared to total assets, measuring the income generated from total assets. From the ROA index, it is possible to evaluate the efficiency of capital use of a business or business project over a certain period of time. The higher the ROA, the better, showing that the company earns more profit.
Uses of ROA index
ROA index is often used by business managers, investors, and lending banks to evaluate operating results, compare the efficiency of asset use of businesses with each other, and evaluate the level of asset intensity. Specifically as follows:
Evaluating operating results
ROA index shows the amount of profit earned per 1 dong of the asset. Based on that, business owners or managers can evaluate the efficiency of business operations. Comparing the ROA index between different projects of the enterprise helps managers grasp which plan is bringing better or worse efficiency to make appropriate and timely adjustments. Banks can also rely on this ROA index to decide whether to lend/not to lend, loan amount, loan term, and interest rate.
Comparing the asset utilization efficiency of enterprises
ROA is often used by managers and investors to compare enterprises in the same industry and the same scale. From there, managers can evaluate the business efficiency of the enterprise, as a basis for developing better improvement plans, and investors have a basis to make appropriate investment decisions.
The reason is that ROA is often only used to compare enterprises in the same business field because different industries have different ROAs. Typically, in industries that are capital intensive and have high fixed asset costs, and the number of assets (the denominator in the ROA formula) is large, the ROA of these companies is often low. However, companies with large assets can also have a large ROA if their income is high enough.
Assessing the level of asset intensity
ROA can be used by managers to assess the level of asset intensity of a business. The lower the ROA, the more asset-intensive the business is, and vice versa.
Limitations of ROA
What are the limitations of ROA? The first limitation is that it does not give accurate results when comparing businesses in different business sectors due to differences in assets. Therefore, if you want to compare the efficiency of asset use of 2 businesses in different industries, you should use another index.
Second, the basic ROA calculation formula is limited because it does not clearly distinguish between assets formed from equity and assets formed from liabilities (loan capital), leading to inconsistencies in the calculation formula. Specifically, the numerator is net income, which is the profit for equity investors, and the denominator is assets including liabilities and equity.
On the other hand, not clearly distinguishing can lead to incorrect assessment due to the impact of interest. Specifically, if the income generated from assets based on borrowed capital is not enough to pay the interest on the loan, even though ROA is high, the efficiency of using the enterprise’s assets is not good.
To resolve this contradiction and eliminate the impact of assets generated from borrowed capital, there are 2 other ROA calculation formulas used instead:
- Formula 1: ROA = Net Income + [Interest Expense × (1 – Tax Rate)] Total Assets
- Formula 2: ROA = Operating Income × (1 – Tax Rate)Total Assets
What is a good ROA index?
As a general rule, an ROA above 5% is generally considered good, and above 20% is considered very good. However, ROA alone over a period of time cannot accurately assess a company’s financial performance. To improve accuracy, you need to monitor the company’s ROA for at least 3 years. If a company can maintain an ROA above 10% for at least 3 years, this shows good business performance and efficient use of assets.
ROA examples
Here is an example of the net profit, total assets, and ROA figures of three retail companies, including Macy’s (M), Kohl’s (KSS), and Dillard’s (DDS) over the past 12 months:
| Company | Net profit | Total assets | ROA |
| Macy’s (M) | $1.7 billion | $20.4 billion | 8.3% |
| Kohl (KSS) | $996 million | $14.1 billion | 7.1% |
| Dillard (DDS) | $243 million | $3.9 billion | 6.2% |
Based on the table above, it can be seen that Company M has a better ability to convert assets into profits than the two companies KSS and DDS. In the past 12 months, Company M has had a more effective operating plan than the other two companies.
The relationship between ROA and ROE
ROA and ROE are both used to measure the efficiency of capital use of a business. However, ROA measures the efficiency of using all capital sources (assets = capital sources), while ROE only measures the efficiency of using equity capital. This is clearly shown in the basic calculation formula:
ROA = Net IncomeLiabilities + Equity
ROE = Net IncomeEquity
Debt is considered a common financial leverage of businesses. Based on the above formula, it can be seen that the more financial leverage a business uses, the larger the ROE is compared to the ROA of that business.
In addition, ROA is mainly applied by managers, business owners, and banks to evaluate the efficiency of capital use of a business, ROE is mainly applied by investors to measure the efficiency of using the capital they invest in the business.
Conclusion
The above is a detailed answer to the question of what is ROA, along with its meaning, uses, ROA calculation formula, and comparison of ROA and ROE. Unich Analysis hopes that this information can help you understand ROA, understand how to calculate it to effectively apply it in evaluating businesses and business projects before deciding to invest.
