How to Calculate Return on Assets or ROA

How to Calculate Return on Assets or ROA explained by professional Forex trading experts the “ForexSQ” FX trading team. 

How to Calculate Return on Assets or ROA

Now that you’ve made it this far in these investing lessons, it is time for me to teach you how to calculate a financial ratio known as return on assets or ROA for short.  As you seek to improve your investing skills and become a more experienced analyst, you’ll find that ROA is an important measurement because it gives you an idea about the underlying nature of the business or enterprise you are studying in a way that is different from the return on equity formula.

 This is especially true for certain sectors and industries, and not always in the way you might think.

Using ROA in the Real World

This real-world example of using the ROA ratio comes from a family friend of mine.  This gentleman is a successful banker, business owner, and investor who has managed to sail through practically every banking crisis of the past few decades, both at the institution he runs and the banks in which he holds an investment, due in no small part to his conservatism.  Part of his success involves looking at the return on assets figure.  If a bank’s return on asset metric gets too high compared to what he thinks it should be after looking through some of the details of the loan book and business model, he avoids it because, to him, it indicates management is taking too many risks.  On the other hand, such a concern would not apply to a non-leveraged entity such as a software company.

I’m getting ahead of myself.  First, you need to learn the definition of return on assets, why it is important, and how to calculate it for yourself.

What Is Return on Assets and Why Is It Important for Investors Understand ROA?

Whereas asset turnover tells an investor the total sales for each $1 of assets on the balance sheet, return on assets, or ROA for short, tells an investor how much after-tax profit a company generated for each $1 in assets.

 In other words, return on assets measures a company’s net earnings in relation to all of the resources it had at its disposal; the shareholders’ capital plus short and long-term borrowed funds. Thus, return on assets is the most stringent and excessive test of return to shareholders.

If a company has no debt, the return on assets and return on equity figures will be the same.

How to Calculate Return on Assets

There are two acceptable ways to calculate return on assets.

  • Method 1: Net Profit Margin x Asset Turnover = Return on Assets
  • Method 2: Net Income ÷ Average Assets for the Period = Return on Assets

Examples of How to Calculate Return on Assets Using Both Methods

Method 1
As described above, method one requires that we calculate net profit margin and asset turnover first before we can calculate return on assets. In most of your analyses, you will have already calculated these figures by the time you get around to return on assets. For illustrative purposes, we’ll go through the entire process using Johnson Controls as our sample business.

When I first wrote this lesson back in 2002, I used the data from the prior year’s Johnson Controls Form 10-K and annual report, which you can still find at the bottom of this page.

Although I could update this information now, the return on assets measurement is timeless so it proves a point by keeping the original figures here. In fact, it can be useful to measure the return on assets a company produces over a multi-year period and watch for changes. From time to time, this can let you know something is happening in the business that could be a harbinger of future prosperity or a Cassandra warning of coming doom.

Our first step is to calculate the net profit margin. To do this, divide $469,500,000 (the net income) by the total revenue of $18,427,200,000. We come up with 0.025 (or 2.5%).

We now need to calculate asset turnover. We average the $9,911,500,000 total assets from 2001 and $9,428,000,000 total assets from 2000 together and come up with $9,669,750,000 average assets for the one-year period we are studying.

Divide the total revenue of $18,427,200,000 by the average assets of $9,660,750,000. The answer, 1.90, is the total number of asset turns. We have both of the components of the equation to calculate return on assets:

.025 (net profit margin) x 1.90 (asset turn) = 0.0475, or 4.75% return on assets

Method 2
The second method for calculating ROA is much shorter. Simply take the net income of $469,500,000 divided by the average assets for the period of $9,660,750,000. You should come out with 0.04859, or 4.85%. [Note: You may wonder why the ROA is different depending on which of the two equations you used. The first, longer option came out to 4.75%, while the second was 4.85%. The difference is due to the imprecision of our calculation.  Specifically, we truncated the decimal places; e.g., we came up with asset turns of 1.90 when in reality, the asset turns were 1.905654231. If you opt to use the first example, it is good practice to carry out the decimal as far as possible.

Is a 4.75% ROA good for Johnson Controls? A little research shows that the average ROA for Johnson’s industry is 1.5%. It appears Johnson’s management is doing a much better job than its competitors. This should be welcome news to investors.

Using Return on Assets as a Measure of Asset Intensity, or How “Good” a Business Is

The return on assets figure is also a sure-fire way to gauge the asset intensity of a business.  The lower the profit per dollar of assets, the more asset-intensive a business is. The higher the profit per dollar of assets, the less asset-intensive a business is. All things being equal, the more asset-intensive a business, the more money must be reinvested into it to continue generating earnings. This is a bad thing. If a company has a ROA of 20%, it means that the company earned $0.20 for each $1 in assets. As a general rule, anything below 5% is very asset-heavy while anything above 20% is asset-light.

Companies such as telecommunication providers, car manufacturers, airlines, and railroads are very asset-intensive, meaning they require big, expensive machinery or equipment to generate a profit. Advertising agencies and software companies, on the other hand, are generally very asset-light. Since I mentioned software companies earlier and am coming back to them, again, I’ll use them to demonstrate my point. Think about what happens once a software program has been developed. It is mass copied to DVDs or uploaded to the cloud for digital distribution. Other than on-going updates, each subsequent unit doesn’t require a comparable amount of labor. That is, the business model is scalable. A widget factory, in contrast, has to do the same amount of work to produce each widget. The result is that a single major hit can transform a relatively small software firm into a titan in a short period of time. The biggest problem is getting the right people to do the job; the managers, programmers, and sales staff.

Johnson Controls Financial Statement Excerpts

Johnson Controls
2001 Income Statement Excerpt
Period EndingSep 30, 2001Sep 30, 2000Sep 30, 1999
Total Revenue$18,427,200,000$17,154,600,000$16,139,400,000
Cost of Revenue$478,300,000$472,400,000$419,600,000
Preferred Stock and Other Adjustments($8,800,000)($9,800,000)($13,000,000)
Net Income Applicable to Common Shares$469,500,000$462,600,000$406,600,000
Johnson Controls
2001 Balance Sheet Excerpt
Period Ending200120001999
Long Term Assets
Long Term Investments$300,500,000$254,700,000$254,700,000
Property, Plant and Equipment$2,379,800,000$2,305,000,000$1,996,000,000
Intangible AssetsN/AN/AN/A
Accumulated AmortizationN/AN/AN/A
Other Assets$439,900,000$457,800,000$457,700,000
Deferred Long Term Asset ChargesN/AN/AN/A
Total Assets$9,911,500,000$9,428,000,000$8,614,200,000
Total Stockholders’ Equity$2,985,400,000$2,576,100,000$2,270,000,000
Net Tangible Assets$738,100,000$442,800,000$173,100,000

How to Calculate Return on Assets or ROA Conclusion

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