Return on total assets (ROTA) is a financial metric used in corporate finance to assess how effectively a business is utilizing its assets to generate profits by comparing its earnings before interest and taxes (EBIT) to its total net assets. Everything a company spends money on must be beneficial to operational efficiency in some way.
- Return on total assets (ROTA) helps assess how effectively a company is managing its assets.
- Low ROTA means a company is underutilizing its assets.
- There are ways to increase ROTA, however, including increasing profits or decreasing total assets.
- Increasing profits requires either boosting revenue or decreasing assets.
- Reducing total assets can mean selling poorly performing fixed assets.
A low ROTA ratio is an indication that a company has anemic profits or is over-invested in assets that are not adequately contributing to the bottom line. This makes a company less appealing to lenders and shareholders, so a prudent business strategy focuses on optimizing this ratio.
How to Improve Return on Total Assets (ROTA)
Although the definition of a healthy ROTA varies from industry-to-industry, there are two ways any business can improve its performance: increase profits or decrease total assets.
The numerator of the ROTA calculation is EBIT. This profitability metric indicates how much revenue remains as profit after accounting for all expenses other than taxes and interest payments on debt. EBIT reflects a company's operational profitability by excluding those contractual obligations for which a company is liable regardless of revenue.
Since EBIT accounts for all expenses except for taxes and debt payments, there are a number of ways to increase this figure. Increasing production or selling price will increase revenues, assuming that sales remain consistent. Finding cheaper sources for the materials needed to produce goods for sale lowers the cost of goods sold (COGS), leaving a greater portion of revenue to cover operational expenses. Examples of ways that operational expenses can be reduced are by moving to a cheaper part of town, downsizing facilities to the bare essentials or eliminating employees.
While there are numerous ways to increase revenues or decrease expenses, each has its consequences. Increasing price risks alienating consumers. Increased production runs the risk of letting inventory sit on the shelves if the supply outweighs the demand. Decreasing the cost of materials may require making a lower-quality product, which may mean losing sales to a competitor that doesn't cut corners.
Changing locations and downsizing staff have a huge impact on the people that work for the company and the reputation of the business within the community. Although increasing revenue may seem straightforward on paper, these types of decisions require careful analysis.
Decreasing Total Assets
The other option for increasing a company's ROTA is to decrease its total net assets. To calculate net total assets, subtract expenses for depreciation and allowances for bad debt from a company's total assets. There isn't much to be done about the depreciation of assets or the possibility that debtors will default on payments, which leaves reducing the initial asset total.
Total assets include everything a company owns, including fixed assets such as equipment and real estate, as well as liquid assets such as cash and marketable securities. In an effort to try and raise its ROTA, a business will examine all of its holdings to determine which assets aren't contributing to operational efficiency. Selling fixed assets such as vehicles or equipment that aren't being used and then renting or leasing items as needed is an effective way to reduce equipment costs.
Inventory also has a significant effect on total assets, so maintaining production levels that are in line with sales ensure that unneeded inventory isn't unnecessarily inflating total assets.