What is 'Return On Average Assets - ROAA'
Return on average assets (ROAA) is an indicator used to assess the profitability of a firm's assets, and it is most often used by banks and other financial institutions as a means to gauge financial performance. ROAA is calculated by taking net income and dividing it by average total assets. The final ratio is expressed as a percentage of total average assets.
BREAKING DOWN 'Return On Average Assets - ROAA'
Return on average assets (ROAA) shows how efficiently a company is utilizing its assets and is also useful in a comparison among peers in the same industry. Unlike return on equity, which measures the return on invested and retained dollars, ROAA measures the return on the assets purchased using those dollars.
ROAA is calculated by dividing net income by average total assets. Analysts find net income on the income statement, which is reported on an annual and a quarterly basis. The income statement provides an overview of performance over a given time period. If the income statement is annual, it provides a summary of income over the previous year. Likewise, if the income statement is quarterly, it provides information about net income over the quarter.
Analysts can look to the balance sheet to find assets. Unlike the income statement, however, the balance sheet is a snapshot in time. It does not provide an overview of changes made over a certain time period, but at the end of the time period. To arrive at a more accurate measure of return on assets, analysts like to take the average of assets from the beginning and end of the period that was used to define net income.
If company A has $1,000 in net income at the end of year 2, the analyst can find the assets from the balance sheet at the end of year 1, and then average them with the assets at the end of year 2 for the ROAA calculation. Assume assets at the end of year 1 are $5,000, and increase to $15,000 by the end of year 2. The average of assets in year 1 and year 2 is $10,000. The ROAA is calculated by taking $1,000 and dividing by $10,000. The answer is 10%.
If the return on assets is calculated using assets from only the end of year 1, the return is 20%, because the company is making more income on less assets. However, if the analyst calculates return on assets using only the assets measured at the end of year 2, the answer is 6%, because the company is making less income with more assets. This is why analysts use an average to provide a more accurate measure of asset efficiency over a given time period.