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What is Return on Assets (ROA)?
All the stakeholders of a corporation want to know that howthe firm is performing, and how efficiently it is using the available resourcesin order to generate higher value for the stakeholders. Financial analysts usesome ratios to give the stakeholders a guess about the performance of the firm.One of these financial ratios is ‘Return on Assets’ that describes the incomepercentage of the firm through its resources. It is denoted as netincome divided by total assets. Total assets are all the business assets eithergot through creditors’ funds or investors’ funds. The ROA percentage shows howeffectively and efficiently the management of the firm is capitalizing itsavailable assets. This ratio best helps you as an investor when you arecomparing different firms to invest in. The firm having higher ROA ratio willbe managing its resources in a better way.
How to calculate Return on Assets Ratio?
Return on Assets Ratio = Net Income / Total Assets
Importance of Return on Assets
An investor can get a guessabout a firm’s total sales per dollar of its assets as well as profitgenerating ability of the firm. A comparison of current ROA ratio to past ROAratio will let the investor as well as the firm that either firm is getting betterin its assets management ability or performing worse than past. It is animportant financial ratio an investor should know about that how the firm isturning its assets into income. An investor should look for a company aftercomparative analysis that which one is turning its assets into income andshould invest in that one.
In the capital structure, there are debts and equity portion, and the firm pays either interest or dividends on these investments. A firm earning less income on these investments would not be paying sufficient dividends to its stockholders as it must have to pay interests before and this firm would not be an attractive one for the investors.
ROA also provides the firm a way to get more efficient way of its resource utilization. Firms by increasing prices will get higher returns and can increase their ROA ratio. The other way is to use the assets up to their maximum limit to get higher value from them. While comparing the ROA ratios for different firms, investors should keep in mind that he/she is comparing the ratios of same industry.
Although ROA provides a good measure to get a guess about firms’ performance but it can’t tell about the individual contribution of equity and debts towards the performance.