Return on Assets (ROA)
Return on Assets (ROA) assess how profitable a business firm is relative to its total assets. In turn, it assess how efficiently a business firm uses its assets. Generally, ROA should be employed to compare companies in the same industry. Everything else being equal, a more eminent ROA is better, as it means that a business firm is more efficient about employing its assets.
ROA = (Net Income + Interest Expense) ÷ (Average Assets throughout the period)
Calculated by dividing a firm's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment". It could be cited as:
Return on Asset =Net Income
Total Asset
Companies employ both debt and equity to acquire their assets, and ROA could be employed to determine how effectively they are turning their funding into earnings. The crucial difference between ROA and Return on Equity (ROE), the other major profitability ratio, is that the ROA remain relatively unaffected by a firm's choice of capital structure -- the choice of employing debt versus equity to fund operations.
In the case of the ROA, the influence of taking more debt is negated by adding back interest expense to net income in the numerator, and by employing average assets (in a given period), instead of equity in the denominator. All the same, the choice of capital structure structure could still influence the ratio due to the treatment of interest in computing taxes -- since a business firm with a high debt pays less taxes (due to more eminent interest expense) equated to a business firm with no debt.
ROA alters from the industry to industry. For illustration: The ROA for service-oriented industries, such as the banking industry, is significantly more eminent than that of capital-intensive industries such as the construction industry. Its usefulness in equating one industry with another is limited as the risks and accounting variations of various industries are not captured by the ratio. Moreover, the ratio could only be computed for companies earning a net profit, and thence would mislead an investor trying to compare two industries with various levels of profitability. For illustration, an industry, such as the software industry, where a lot of the companies are making a loss and some are earning spectacular profits, could not be equated, on the basis of ROA, to the industry such as utilities, where many companies make a small-scale net profit.
The assets of the business firm are comprised of both debt and equity. Both of these types of financing are employed to fund the operations of the business firm. The ROA figure renders investors an idea of how effectively the business firm is converting the money it has to invest into net income. The more eminent the ROA number, the better, since the business firm is earning more money on less investment. For illustration, if one business firm has a net income of $1 million and total assets of $5 million, its ROA is 20%; all the same, if another business firm earns the same amount but has total assets of $10 million, it has an ROA of 10%. Based on this illustration, the first business firm is better at converting its investment into net profit. When investor really think about it, management's most significant job is to make wise choices in allocating its resources. Anybody could make a net net profit by throwing a ton of money at the problem, but very little managers stand out at making large profits with little investment.
The simplest way to compute the ratio is to divide net income by total assets. All the same, this leads to two issues:
The ratio is affected by capital structure as net income is computed after taking out interest expense.
Taking the total assets at the end of the financial year is in a conceptual manner misleading, as the net income was earned employing the assets the business firm owned earlier. For illustration: If the business firm had a stock issuance at the end of the financial year and increased its cash position, its ROA would be affected by the fact that its assets increased. All the same, in reality, the business firm only had the extra assets for the day and those funds were not available throughout a year.
In order to address these issues, investor employ the modified version of the formula:
ROA = (Net Income + Interest Expense) ÷ (Average Assets throughout the period)
The formula addresses the two issues mentioned above by adding up back interest disbursements, and taking average assets held throughout a period instead of total assets at given point in time. Average assets is computed by taking the average of assets at a starting of period and assets at end of the period.
Students can get solutions for Return on Assets (ROA) in finance queries online. ExpertsMinds interactive academic session will make learning Return on Assets (ROA) in finance easy. Get answers online to all your questions, assignments, homework on Return on Assets (ROA) in finance , under the expert guidance of our tutors. Expertsmind.com offers Return on Assets (ROA) in finance online tutoring service, Return on Assets (ROA) in finance homework help and Return on Assets (ROA) in finance solutions anytime from anywhere 24x7.
ExpertsMind.com - Return on Assets Assignment Help, Return on Assets Homework Help, Return on Assets Assignment Tutors, Return on Assets Solutions, Return on Assets Answers, Risk and Return Assignment Tutors