Why Amazon and Netflix Pay $0 in Corporate Taxes?
Amazon and Netflix are two of the most profitable firms in the entire world. For instance, last year, Amazon alone made over $12 billion in profits. However, it paid $0 in taxes! To make matters worse, the company was owed money in the form of tax rebates. This means that the federal government was actually […]
The Role of Government in Financial Systems
In the previous articles, we have already established that the financial system of any country is the key to its economic prosperity. It is for this reason that these financial systems need to be appropriately maintained. The government is the party that is most suited to this maintenance of financial systems. However, too much government […]
Revenue From Releasing Players for International Tournaments
Professional sports athletes play for certain sports franchises throughout the year. However, these same players also represent their nation when it comes to international events. One good example would be the FIFA World Cup. It needs to be understood that all good players such as Lionel Messi and Cristiano Ronaldo play for their respective countries. […]
Mergers and Acquisitions: A New Perspective
The nature of mergers and acquisition activity has drastically changed over the past few years. Earlier, most of the mergers and acquisitions happened because companies wanted to do horizontal or vertical integration. They either wanted to team up with their competitors and enjoy economies of scale, or they wanted to team up with their suppliers […]
Bridge Loans in Investment Banking
Investment bankers play different types of roles when it comes to capital raising. Most of the time, they are middlemen who ensure that the requirements of both parties are met and that the deal goes through smoothly. However, often the acquiring party falls short of cash to complete the acquisition. In such cases, it is […]
Another metric that is widely used by investors to gauge the profitability of a company is Return on Assets (ROA). More about this very important ratio has been stated in this article.
Return on Assets = Earnings / Asset Base
The Return on Assets (ROA) ratio shows the relationship between earnings and asset base of the company. The higher the ratio, the better it is. This is because a higher ratio would indicate that the company can produce relatively higher earnings in comparison to its asset base i.e. more capital efficiency.
The ROA ratio assumes that the assets have been valued fairly on the books. However, in real life, it is a known fact that companies keep over and/or under valuing their assets to reduce taxation. This may affect the ROA adversely and reduce its usability as a profitability metric.
The Return on Assets ratio assumes that the company is using all its assets to run the day to day operations. This assumption is likely to be proved incorrect. A lot of companies hold significant cash on their balance sheet. The most valuable company in the world Apple Inc is one such example. Also many other companies hold a lot of impaired and obsolete assets which they plan to sell in the near future. This brings down the Return On Assets (ROA) ratio.
Return on assets compares the earnings that a company has generated to its asset base. The asset base could be financed by equity or by debt but it will not make a difference. Return on Assets is therefore independent of leverage.
Return on Assets is very sensitive to the stage of growth that a company is currently experiencing. In the introduction and growth stage, companies invest a lot of money to create asset bases. They may not use the asset base immediately and the benefits may be realized years later. Hence, two companies in the same industry, but at different stages of growth, will have very different Return On Assets.
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