Definition of Return on Total Assets
Return on total assets, often referred to as return on assets or ROA, is a profitability ratio that measures how efficiently a company is using its assets to generate earnings. It shows the amount of money a company is earning for every $1 of assets. A company with a higher return on total assets compared with its competitors indicates efficient management.
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Calculation
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Return on total assets is calculated by dividing net income by total assets. You can find net income on the income statement and total assets on the balance sheet. As an example, a company with $200,000 in net income and $1 million in assets has a return on total assets of 0.2, or 20 percent: $200,000 divided by $1 million equals 0.2, or 20 percent.
Net Income Variation
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To exclude the effect of financing costs on net income when calculating return on total assets, add interest expense to net income before dividing by total assets. This shows a company's effectiveness in generating profits without considering how its assets are financed. A company with $200,000 in net income, $20,000 in interest expense and $1 million in assets has a return on total assets of 0.22, or 22 percent: $200,000 plus $20,000 divided by $1 million equals 0.22, or 22 percent.
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Total Assets Variation
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Because the balance sheet only reports assets at the end of the reporting period, use average total assets in the denominator of the return on total assets calculation to get a better representation of a company's use of assets throughout the period. The average total assets are equal to total assets from the current period plus total assets from the prior period divided by two. A company with $1 million in assets in the current period and $600,000 in assets in the prior period has $800,000 in average total assets.
Interpretation
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A higher return on total assets is better, but its importance varies widely among industries. A software company might have a higher return on total assets compared with a utility company with a large investment in power plants, but isn't necessarily more efficient. Look for increasing and decreasing trends in a company's return on total assets over time, and compare it to its competitors and the industry average to gauge the efficiency of management.
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