What Is the 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. It is also known as simply return on assets (ROA).
The ratio shows how well a firm's assets are being used to generate profits. 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.
The Formula for Return on Average Assets Is
ROAA=Average Total AssetsNet Incomewhere:Net Income=Net income for the same period as assets
Return On Assets (ROA)
How to Calculate Return on Average Assets – ROAA
ROAA is calculated by dividing net income by average total assets. Net income is found on the income statement, which provides an overview of a company's performance during a given time period. Analysts can look to the balance sheet to find assets.
Unlike the income statement, which shows growing balances through the year, the balance sheet is only 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 the asset balances from the beginning and end of the same period that was used to define net income.
What Does ROAA Tell You?
Return on average assets (ROAA) shows how efficiently a company is utilizing its assets and is also useful when assessing peer companies 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.
The ROAA result varies greatly depending on the type of industry, and companies that invest a large amount of money up front into equipment and other assets will have a lower ROAA. A ratio result of 5% or better is generally considered good.
- The ROAA shows how well a company uses its assets to generate profits and works best when comparing to similar companies in the same industry.
- The formula uses abverage assets to capture any significant changes in asset balances over the period being analyzed.
- Companies that invest heavily upfront into equipment and other assets typically have a lower ROAA.
Example of How to Use ROAA
Assume that Company A has $1,000 in net income at the end of Year 2. An analyst will take the asset balance from the firm's balance sheet at the end of Year 1, and average it with the assets at the end of Year 2 for the ROAA calculation.
The firm's assets at the end of Year 1 are $5,000, and they increase to $15,000 by the end of Year 2. The average assets between Year 1 and Year 2 is ($5,000+$15,000)/2 = $10,000. The ROAA is then calculated by taking the company's $1,000 net income and dividing by $10,000 to arrive at the answer of 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 fewer 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.
Analysts use average assets for this reason because it takes into consideration balance fluctuations throughout the year and provides a more accurate measure of asset efficiency over a given time period.