Return on assets (ROA) measures how much profit our assets are generating. It tells you what percentage of every dollar invested in the business was returned to you as profit. The total assets figure shows how many dollars are being utilized in the business to generate profit.
ROA shows how effective the company is at using those assets to generate profit. The higher the ROA, the better the utilization of assets. That is, a high ROA tells you that you are efficiently and effectively using your assets to generate a profit.
Return on assets is calculated by dividing net profit by total assets:
For example, if a company’s net profit was $315 and its total assets was $5,400, then its return on assets is:
315 / 5,440 = 5.8%
(Excerpts from Financial Intelligence, Chapter 21 – Profitability Ratios)
This measure isn’t quite as intuitive as the ones we already mentioned, but the fundamental idea isn’t complex. Every business puts assets to work: cash, facilities, machinery, equipment, vehicles, inventory, whatever. A manufacturing company may have a lot of capital tied up in plant and equipment. A service business may have expensive computer and telecommunications systems. Retailers need a lot of inventory. All these assets show up on the balance sheet. The total asset figure shows how many dollars, in whatever form, are being utilized in the business to generate profit. ROA simply shows how effective the company is at using those assets to generate profit. It’s a measure that can be used in any industry to compare the performance of companies of different size.