The return on assets formula calculates the net earnings generated by total assets during a period of time. Also known as ROA, this financial ratio shows how effectively a company uses its assets to generate money.

It tells an investor or a manager how much after-tax profit each dollar of assets generates. For example, ROA of 10% means that a company makes $0.10 of net income for every $1 of assets.

How to calculate return on assets?

Return on assets is calculated by dividing net income by average total assets. Return on assets is presented as a percentage, so this number should be multiplied by 100.

Return\;on\;assets = \frac{Net\;income}{Average\;total\;costs}

Alternative calculation

Another method of calculation of return on assets is to multiply net profit margin by assets turnover. This method is a bit more complicated than the first one because it needs more calculations. But if you analyse a company, you will have already known net profit margin and assets turnover ratio by the time you get to calculate ROA.

Return\;on\;assets = Net\;profit\;margin \times Assets\;turnover

Net profit margin is a relation between revenue (all the money received by a company during a period of time) and net income (revenue – cost of sold goods – operating expenses – interest – taxes – other expenses, i.e. the money a company actually earned). It’s tells us how much income is generated from the revenue.

Assets turnover informs us about a company’s ability to generate sales from its assets. It’s a ratio that measures a company’s total sales in relation to the average value of its assets.

Return on assets ratio explained

Since the main purpose of assets is to create income, ROA ratio helps investors and management to understand how well a company uses its property to create money. For example, ROA of 5% means that every dollar of invested capital generates 5 cents of net income.

As well as a lot of financial ratios, return on assets should be compared:

  • In time for the same company. By comparing ROA in time, we can create a trend and look for positive or negative changes.
  • With other companies in the same industry. It allows us to compare a given company with its competitors.

Return on investment tells how many assets a company should have in order to get a certain amount of profit. In other words, it tells us about how asset-intensive or asset-light a company is. Although, this number is different for every industry, as a reference point ROA <5% is considered as asset-intensive and ROA>20% as assets-light.

For example, manufactories or transport companies are very asset-intensive because they need a lot of expensive equipment to operate. Software companies or law firms are very asset-light because software, computer programs and people create profit it such companies.

Examples of return on assets calculation

Example 1.

  • A company’s annual net income for the past fiscal year was $400,000
  • Total assets were $ 9,000,000 in the beginning of the year and $11,000,000 at the end of the year, which means average total assets were $10,000,000.

Return on assets for this company is calculated as:

Return\;on\;assets = \frac{\$400,000}{\$10,000,000}

This means that this company generated $0.04 of net profit for every $1 of assets, giving the ROA of 4%.

Example 2.

  • A company’s annual sales (revenue) for the past fiscal year were $600,000.
  • A sum of cost of sold goods, operating expenses, interest, taxes and other expenses was $200,000.
  • Total assets were $ 2,000,000 in the beginning of the year and $3,000,000 at the end of the year, which means average total assets were $2,500,000.
  • Net income was $400,000 (revenue – costs).

Step 1. Net profit margin

Net\;profit\;margin = \frac{\$400,000}{\$600,000} = 66.7\%

Step 2. Assets turnover

Assets\;turnover = \frac{\$600,000}{\$2,500,000} = 0.24

Step 3. Return on assets

Return\;on\;assets = 0.667 \times 0.24 = 0.16 = 15\%