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Return on Assets – What is it and How do you Calculate it?

Return on Assets (ROA) is a valuable metric which is often overlooked. Thus, what follows is a short introduction that will bring you closer to understanding the subject.

return on assets
Unlike a profit and loss statement or income statement, return on assets gives you a sense of the efficiency of your business. (© pexels.com)

What is Return on Assets?

Return on Assets is a way of measuring the profitability of a business in a given period by comparing the net income to the average total assets (everything the business owns); in plain terms, it compares how much the company’s assets are worth in total to how much profit it has made in a given time. ROA tells us whether the amount of profit the business has made is proportionate to the amount of equipment, inventory, land, and other things it owns. A high return on assets can mean a company has low overhead to begin with, or it can mean that it is managing its resources efficiently. It’s important to have a basic understanding of what the numbers mean in order to interpret them correctly when they apply to your business.

Calculating Return on Assets

Return on Assets is calculated as follows:

Return on Assets = Net Income/Average Total Assets
  • Net Income is the company’s income after all expenses are deducted – overhead costs, salaries, amortization, and rent, for example. It includes any one-time income and loss that has to do with the business as well, such as income earned from investments, and represents what people commonly think of as the “bottom line” profitability of a company.
  • Average Total Assets means the average of the total assets in the company during the period the report looks at. Because assets – such as property, vehicles, and furniture – can be bought and sold, the value of total assets will fluctuate over time. Average Total Assets captures their average value over the period of time the net income in question was earned.

Managing Return on Assets – Tips

The ROA report is often used internally in business to check up on how efficiently its resources are being used. People with a low return on assets might look into keeping less money tied up in inventory that’s not being sold, or making sure equipment is actually needed and being used instead of just sitting around. But while managing your return on assets is an important part of running a business, it’s not a one-size-fits all number. Below are a few tips on how to keep your business assets working for you, and how to understand the reports associated with them.

1. Know your Industry

Different industries can have different expectations for ROA; a manufacturer that needs a lot of inventory and equipment to produce a net income will have a lower return on assets than a graphic designer, who only needs a computer and a few other materials to produce a net income. Since industries without a lot of up-front costs will naturally have a higher ROA, it’s incumbent on the business owner to know a little about how their numbers compare to their industry as a whole. Knowing a little about the industry standard for ROA will help you be able to gauge whether or not the ratio for your own business is healthy.

2. Keep track of Your Numbers

In order to keep yourself informed of the health of your business, it’s important to check your financial reports once a month. Keeping up to date will give you an idea of the general direction you’re headed in – your return on assets might dip predictably when you purchase new equipment, but if it steadily declines over a series of months, it may signal a problem. Accounting software like Billomat can help you keep on top of these reports with features like Billomat’s dashboard, which give you a range of key performance indicators (KPIs) to view every time you open the software.

3. Keep an Eye on Growth

A particular time to keep a close eye on ROA is when your business is expanding. You’ll want to be able to assess whether existing systems are working for you, or if it’s time for an upgrade. By looking at the potential numbers for profit and the increased expense of extra assets, you can gauge whether new purchases will have an overall financial benefit to your business before purchasing them. If you are making new purchases without the profit to back them up, your ROA will decrease and indicate that it’s time to hold back on major purchases until your sales start to pick up. Alternately, a sharp rise in profits might make your ROA look better, but a sudden increase might mean you need more equipment to support your business.

4. Look at the Big Picture

While it’s generally a good idea to aim for a high ROA, it’s important to look at the numbers in light of what’s happening in real time. For example, an unnaturally high Return of Assets may seem like a good sign at first, but may not be a sign of business health if it’s because equipment needs to be replaced. Eventually, profits will start to suffer once the equipment breaks down or becomes inefficient. Likewise, a low ROA may be inevitable for in the first year of a business, before it has a chance to become very profitable – but this doesn’t mean you shouldn’t buy the equipment you need! Instead, make sure you’re looking at these numbers in terms of what is happening with your business in the real world.

While these reports may be confusing at first, return on assets is a great report to get to know. Unlike a profit and loss statement or income statement, return on assets gives you a sense of the efficiency of your business. When you’re looking at reports over time, they will eventually stop being just numbers, and instead start being the language your money is using to tell you whether or not it’s being used wisely.

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