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

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