MSG Team's other articles

12249 Objectives of Accounting

Every activity that a business firm does must be done for a reason and accounting is no exception. Accounting helps the company achieve a myriad of objectives. Here is the list of objectives that accounting helps the company to obtain. Permanent Record Any business firm needs a permanent record of the transactions that it indulges […]

8872 The Deepening Insolvency Theory

Timing is everything when it comes to bankruptcy claims. Any company facing the threat of bankruptcy has a duty to ensure that it maximizes the enterprise value. This means that the company, its lenders, and its managing officers have an inherent duty to ensure that one particular group of stakeholders is not benefitting at the […]

11842 What is Bond Valuation and How is it Calculated ?

One of the Most Important Uses of Discounting The present value of a bond is the sum of all the future cash flows that can be derived from it. In this sense, the valuation of bonds really becomes simple, isn’t it? All we need to do is find out the future stream of payments that […]

11262 Shark Repellent Tactics in Investment Banking

The profession of investment banking has evolved over the years. Earlier, they were only used when companies wanted to issue securities and raise capital. Over the years, companies have realized that investment bankers know how to make securities more palatable to the investor community. Hence, they also know how to run the process in reverse, […]

10970 Responsibilities of Pension Fund Regulators

In the previous article, we have already determined why it is important to closely monitor the workings of pension funds and also to regulate them. However, regulation is a broad concept. It encompasses a wide variety of actions that need to be undertaken. In this article, we will have a closer look at various activities […]

Search with tags

  • No tags available.

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.

Formula

Return on Assets = Earnings / Asset Base

  • Some calculations may include intangible assets while some others may exclude them from calculation of Return on Assets.

Meaning

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.

Assumptions

  • No Write-downs:

    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.

  • Excess Cash and Assets for Sale:

    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.

Interpretation

  • Does Not Depend on Leverage:

    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.

  • Stage of Growth:

    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.

Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

What are Common Size Statements ?

MSG Team

Cash Ratio – Meaning, Formula and Assumptions

MSG Team