Return on Assets (ROA): The Key Metric for Measuring Business Efficiency

When assessing the financial performance of a company, standard measures like revenue and net profit don't always tell the full story. Sometimes you need to dig into more advanced metrics like return on assets (ROA) to get a better understanding of how a company is doing. 

ROA is a ratio that measures a company's profitability relative to its total assets. It shows how well (or poorly) a company is using everything it owns — from machinery to vehicles and intellectual property — to earn money.

Here, we'll take a closer look at what ROA involves, how ROA is calculated, why ROA is important, and more.

What is Return on Assets (ROA)?

Not all profit means the same thing. If a kid's lemonade stand generates $1,000 in profit in one day, for example, that's likely a more impressive use of resources than a cafe generating $1,000. 

In other words, you would generally expect a business with more resources to generate more profit. That's where ROA comes into play, as it tells you how efficiently a company uses its assets — i.e., the things of value that it owns — to generate profit.

Definition of ROA

Put simply, ROA is a measure of a company's profitability compared to its total assets.

A rising ROA indicates improving efficiency, while a ROA that is falling suggests a company might be spending too much on equipment and other assets relative to the profits it is earning from those investments.

Investors or managers can use ROA to assess the general health of the company to see how efficiently it's being run and how competitive it is. 

Quick tip: If you're using ROA to measure a company's relative performance to others, it's important to compare it only to similarly sized companies in the same industry.

How is ROA calculated?

ROA may seem like a complex metric at first glance, but the ROA calculation is usually pretty straightforward.

ROA Formula

The basic return on assets formula is to divide a company's net income by its average total assets. The result is then typically multiplied by 100 to convert the final figure into a percentage. 

Rachel Mendelson/Insider

Let's break these terms down:

• Net income: Revenue minus cost of goods sold minus expenses
• Average total assets: Typically calculated as the total assets on a company's balance sheet at the start of a given period plus the total assets at the end of a given period, divided by two

While this formula is the most popular, it's not the only one used to determine a company's ROA. Katzen says for non-financial companies, it can be helpful to add back interest expenses, rather than deducting them from net income, because of the inconsistency that can come from debt and equity capital being segregated. Also, changing the period measured can make a difference.

"The values can differ if the formula is changed,'' says Adam Lynch, senior quantitative analyst at Schwab Equity Ratings. "Often these alternate versions vary the unit of time used in the calculation."

Quick tip: If a company's ROA is increasing over time, it's usually a good sign that the efficiency of its operations is improving.

ROA Example

Here's an example of how to use data from Nike's financial statements to figure out its ROA for the fiscal year that ended in May 2024.

• First, find Nike's total assets at the end of fiscal 2024: $38.1 billion
• Next, find Nike's total assets at the end of fiscal 2023: $37.5 billion
• Add those together and divide by two to get average assets: $37.8 billion
• Divide its 2024 net income ($5.7 billion) by average assets ($37.8 billion) and then multiply the result by 100, which gives you 15.1%

So putting it all together, your formula looks like this when you plug in all the values:

ROA = (5.7/37.8)*100 = 15.1% 

Interpreting ROA

While calculating ROA is relatively easy, it's still not always clear what the result means. However, there are some general guidelines to follow:

Higher ROA is better

All else being equal, the higher the ROA, the better. Going back to the lemonade stand example, if you're generating $1,000 in net income off of $100 worth of assets, like the lemonade pitcher and table, that's an ROA of 1,000%. In comparison, a cafe that has $100,000 worth of assets like kitchen equipment, retail space, and cash, while generating $1,000 in net income, only has an ROA of 1%.

These different ROAs indicate that if you were to scale up the lemonade stand, like by buying equipment to increase output, you'd potentially gain a much higher return on that investment compared to if you added equipment to the cafe.

Of course, this is an oversimplification, and the results don't always play out like this in practicality. Most of the time, ROA is industry-specific, as a manufacturing company, for example, likely has very different asset requirements than, say, a software business. Also, you should consider trying to only compare similar types of businesses, such as one cafe vs. another, rather than a cafe vs. a lemonade stand, because the variables are very different, even though they're both serving drinks. 

What is a good ROA ratio?

A "good" ROA depends on the company, the time frame of the calculation, and a few other factors. 

"It's all relative," says Lynch. "Better than your competition is what I'd aim for. Generally, you would compare competitive companies or industries."

As a benchmark, though, an ROA of 5% or better is a good place to aim.

"Generally speaking, an ROA of 5% or better is considered 'good,'" says Michelle Katzen, senior advisor at Ritholz Wealth Management. "But it is important to consider a company's ROA in the context of competitors in the same industry, the same sector, and of similar size."

Still, ROAs vary considerably by industry and by economic conditions. During a recession, for example, you might be willing to accept a negative ROA, as long as it's still higher than competitors.

Some examples of ROAs by industry as of September 2024, according to FullRatio, include:

• Airlines: -1.1%
• Consulting services: 6.7%
• Life insurance: 1.3%
• Metal fabrication: 5.6%
• Restaurants: 3.8%

Why ROA is important

ROA can provide deeper financial insights that help stakeholders like investors and managers understand a company's efficiency and possibly the ability to sustain profitability. For example, a low ROA might indicate that if a company needs to invest in new assets to keep up with competitors, profitability could suffer.

Investors

Analyzing ROA for investment decisions helps reveal whether putting money into a company is likely to generate strong income in relation to competitors.

"ROA is used by investors to see how a company's profitability, relative to its assets, has changed over time and how it compares to its peers," says Katzen. "The ROA is one indicator that expresses a company's ability to generate money from its assets."

Typically, a high ROA is a good signal to investors that a company is run well and can continue to generate profits.

Management

ROA can also be used as an internal metric by management trying to assess their financial performance and identify ways to increase profitability. 

For example, if a company tracks its ROA over time and notices that it's decreasing, it might realize that it's not getting much return from investments in assets like machinery or real estate. As such, they may decide that instead of opening a new office, for example, a better use of funds might be to hire more sales staff to see if that can increase net income, and thereby raise the ROA.

ROA vs. ROE

ROA is one of two primary measures managers and investors use to analyze a company's profitability level. The other is return on equity (ROE). Both provide a view of how effective a company is at generating earnings in relation to its resources.

The main difference between the two is that ROE tells investors how much income a company generates relative to the value of shareholders' equity, rather than just assets. The formulas are similar. For ROE, the basic calculation is to divide net annual income by shareholders' equity, or the claim shareholders have on a company's assets, after its debts are paid.

"The main difference between ROA and ROE is the consideration of a company's debt," Katzen says. "When calculating ROE you subtract any liabilities the company has, utilizing net assets (or shareholders' equity) instead of total assets."

In other words, a high ROA could potentially be misleading if the company financed its assets with a lot of debt. In that case, ROE might show that the investors aren't getting as much return on their money as they'd like. However, ROE can also be misleading, such as if a company's debts are almost paid off, and therefore the ROA might tell a better story about the company's direction. In many cases, looking at the two together helps assess a company's financial performance.

Factors affecting ROA

There are several factors that go into ROA, because even though the formula has two main components — net income and total assets — these metrics are affected by other issues, such as:

Profit margin

A profit margin shows net income as a percentage of revenue. For example, a 50% profit margin means that for every $2 of sales, there's $1 of net income. So, the higher the profit margin, the higher the ROA. You can't tell profit margin just by looking at ROA, but knowing this relationship might lead management to make changes, like focusing more on high-margin products, which ultimately provides a better ROA.

Asset turnover

Asset turnover is a calculation of net sales (rather than net income) divided by average total assets. High asset turnover means the company generates strong revenue in relation to its assets, and the higher the revenue, the higher the net income, all else being equal — which therefore also results in a higher ROA. So, a company might need to make changes like investing in assets that have higher potential for generating more revenue to boost these measures, like taking the risk of stocking more inventory to increase sales.

Industry

The industry you're in can have a direct effect on ROA, as different industries have different standards around operating models and capital intensity, meaning how much money you need to invest in assets to operate. 

For example, airlines currently have a negative ROA, perhaps reflecting issues like high fuel costs and other operating expenses which contribute to lower net income. These are also capital-intensive businesses, as airlines need to invest in physical assets, particularly the planes themselves which cost a lot of money.

In contrast, some industries like consulting services have a much higher ROA, as it doesn't take much capital to run these businesses. Even if you have few assets, like not owning any office space and having little cash, you could still generate substantial revenue and net income once you find clients, and therefore you could have a high ROA.

Limitations of ROA

While ROA can tell you a lot about how a company's doing financially, it doesn't tell the full story. Some limitations include:

Accounting practices

Not every company follows the same accounting practices, and even slight differences can affect ROA significantly. For example, a company might account for the purchase of a new asset right away, all at once, vs. amortizing the cost over several years. By accounting for the cost of the new asset right away, that would decrease net income and therefore lower ROA more than when amortizing the cost over time.

Not a complete picture

ROA tells you part of the story but not the full story of a company's profitability. ROE, for example, also accounts for a company's debt more directly, so you might use both metrics to understand a company's position.

Also, while ROA can be used to assess an individual company's performance over time or to evaluate it relative to similar companies in the same industry, it doesn't tell the full story of why the ROA may have changed, such as if economic conditions deteriorated through no fault of the company.

For the most part, though, ROA can provide important insights into how efficient the company is at generating profits, it just shouldn't be the only metric you look at.

"The ROA is one indicator that expresses a company's ability to generate money from its assets," Katzen says. "Generally speaking, the higher the ROA, the more effective a company is at generating income for investors. The more income a company generates, the more likely the investment will appreciate."

FAQs about ROA