What Does It Mean When a Return on Asset Ratio Decreases?

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Return on Assets, or ROA, is a financial ratio used by business managers to determine how much money they're making on how much investment. Different levels of ROA are appropriate to different industries, so no specific number that's a "good" ROA exists. Instead, managers should look at the trend of their performance versus their industry performance. When ROA is negative, it indicates that the company trended toward having more invested capital or earning lower profits.

Calculation

  • ROA equals net income divided by total assets. Since ROA is typically measured over a period of time, calculation uses the average income and average assets. Although this is a ratio, it's usually expressed as a percentage. Industries that are more capital intensive will have a lower ROA than more labor intensive; for instance, as of 2006, the average ROA of software companies was 13.1 percent whereas for auto manufacturers it was 1.1 percent.

Significance

  • In a positive ROA, the company is earning income based on its investment in operating equipment. A lower or negative ROA isn't necessarily bad, however. If an auto manufacturer purchased a new large factory, its assets would go up but its net income for the period would remain steady, thus lowering the ROA. Managers use this information to track trends both in income and in investment, as well as to make purchasing and investment timing decisions.

Example

  • A company with $100,000 in equipment, cash and accounts payable that earned a profit of $20,000 has an ROA of 20 percent. If a company lost money or gained assets in excess of their profits, this will be a negative percentage. For instance, that company purchased a large piece of equipment for $50,000, using their $20,000 in profit plus a $30,000 loan. Now their net profits are -$30,000 and assets are $150,000, resulting in an ROA of -20 percent.

Tip

  • Managers tend to use ROA to determine their performance in getting the most return out of all the company's assets. By contrast, investors primarily use the Return on Investment, or ROI, ratio to monitor how well the company is utilizing their investment.

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