As you know, the balance sheet of an enterprise consists of assets and liabilities, but the effectiveness of asset management allows you to evaluate the profitability ratio of assets. This indicator takes into account the ratio of the company’s net profit and the amount of assets for an effective analysis of the enterprise.
Of course, the profit of a commercial organization, regardless of the nature of its activities, is earned with the help of these very assets, which are taken into account in the return on assets indicator. What does this indicator show, and how to calculate it?
Characteristics of the financial ratio ROA
In English, return on assets is the term return of assets, which is also often used by traders in the abbreviation ROA. This indicator characterizes the return on turnover of all assets owned by the enterprise. Moreover, assets mean not only own funds, but all assets in general.
For an investor, this ratio allows an assessment of the company’s ability to make a profit without taking into account the structure of its capital. The higher the quality of asset management, reflected in the formula calculated for the return on assets, the more justified is the investment in the shares of this enterprise.
How to calculate the Return of Assets ratio?
The calculation procedure is very simple for the analysis of return on assets. The balance formula consists of only two indicators: ROA = NetProfit/Average Assets. If NetProfit is the value of the company’s net profit in annual terms, then Average Assets is the weighted average of assets in circulation. It is calculated using a separate formula, which takes into account the number of assets at the beginning and end of the year.
However, the return on assets in financial analysis is not always calculated on the basis of net profit. Instead of NetProfit, OperatingProfit is substituted into the formula, implying operating profit. How do these two concepts differ:
- Net profit (NetProfit) – the income of the enterprise, which remains at the disposal after the calculation of taxes, fees and other obligations. Most often, this value is used to analyze the profitability of assets.
- Operating Profit is the value calculated by deducting the costs of insurance, rent and other operations from the gross profit of the organization.
In order to conduct a factor analysis for the return on assets for a certain period of time, it is necessary to substitute the required number of days into the above formulas. This number must be multiplied by the NetProfit or OperatingProfit indicator.
What is the norm for the ROA ratio?
Return on assets is determined not only from the profit of a commercial organization. It is important to consider the field of activity of the analyzed company. For the service or retail sector, this ratio is usually lower, and yet it still speaks of effective management of funds.
Since there is no clearly established range within which the normative value is formed, the investor needs to analyze the profitability of the enterprise’s assets in comparison with organizations operating in the same field. The higher the indicator in comparison with competitors, the more stable and profitable is the investment in the shares of this company.
Having understood that the return on assets characterizes the competent use of funds by the company, the investor can make an informed decision during the formation of the portfolio. It is important to consider the comparative value and how the indicator has changed over previous periods. The steady growth of the coefficient speaks only in favor of investing.