December 16, 2024

Understanding ROA: How to Calculate Return on Assets for Better Business Efficiency

Do you have a good understanding of ROA (Return on Assets)? We've all heard the term ROI (Return On Investments). However, you can consider ROA a part of the overall ROI. This metric gauges a company's efficiency in utilizing its assets to generate profits.

In this article, we'll look at:

• The Definition of ROA and how it relates to companies.
• The advantages of knowing your ROA.
• Calculating of ROA.
• Industry examples.
• How a computerized maintenance management system (CMMS) enhances the measurement.

What is ROA? Understanding Return on Assets

Return On Assets measures a company's profitability by comparing its net income to its total assets. It shows how efficiently a company uses its assets to generate profit. Companies use ROA for various reasons. Let's highlight a few and discuss aspects of each.

How ROA Helps Assess Operational Efficiency

Asset Utilization. ROA helps companies understand how well they use assets to generate income. A high ROA indicates that a company effectively manages its assets to create profit. For instance, a manufacturing company might use ROA to assess usage of its plant, property, and equipment to generate revenue.

Operational Improvements. By tracking ROA over time, companies can identify trends and make operational improvements. For example, if a company sees a decreasing ROA, this might indicate underutilized assets or increasing expenses relative to asset use.

Target Setting. Companies can set operational targets based on ROA. A company might aim to increase its ROA by a certain percentage each year.

Benchmarking Performance with Return on Assets

Industry Comparison. Comparing a company's ROA with the industry average provides context for its performance. A higher than industry average ROA indicates that the company uses its assets more efficiently than its peers.

Competitor Analysis. Comparing ROA with direct competitors can highlight competitive advantages or disadvantages. If a competitor has a higher ROA, it might signify a more efficient operation or a better asset mix.

Best Practices. By benchmarking ROA, companies can identify and learn from industry leaders. They can study how these leaders use their assets efficiently and adopt similar best practices.

Using ROA to Identify Areas for Improvement

Underutilized Assets. This might result in a low ROA might indicate underutilized assets. Areas for concern include excess inventory, unused equipment, or inefficient use of space.

Process Inefficiencies. Here, you might see such issues as high production costs, excessive waste, or poor inventory management.

Asset Mix. In this area, a company might find that it has too much cash on hand that could be invested in more productive assets.

How ROA Guides Informed Business Decisions

Asset Acquisition. A high ROA might serve as an incentive for acquiring more assets that could lead to even higher profits.

Asset Disposal. Conversely, look at a low ROA in terms of assets that don't generate sufficient returns. In this case, the company might decide to sell these assets.

Asset Reallocation. How can you use your assets more effectively? Maybe shifting resources from a low-ROA division to a high-ROA division.

Why ROA Matters for Attracting Investors

Profitability Signal. A strong ROA can make the company more attractive to investors.

Growth Potential. A higher percentage might indicate that a company has significant growth potential. Investors often look for current high returns and growth opportunities.

Risk Assessment. Here, we look at consistency. Steady measurements can imply less risk, and stable and efficient operations.

Valuation. Here, the obvious measurement of a high ROA score implies a higher value.

In each of these cases, note that you shouldn't view ROA by itself. Companies will use other financial metrics. Also, consider the industry. ROA can mean something different to different industries.

Understanding ROA Through Industry Examples

Let's look at two industries to see how they have an understanding of ROA.

Retail. Here, the calculation helps evaluate how effectively a company uses its inventory, stores, and other assets to generate sales and profit. For example, Walmart might use ROA to assess how well it's utilizing its vast network of stores and distribution centers.

Walmart's ROA in 2021: Approximately 7.08

Banking. In this example, banks use ROA to measure how efficiently they use assets like loans, investments, and cash to generate profit. A higher ROA indicates better asset utilization.

JPMorgan Chase's ROA in 2021: Approximately 1.2% (Note: ROA tends to be lower in the banking industry due to the nature of their assets and regulations.)

How to Calculate ROA

You obtain ROA through a simple formula. Divide the net income by the total asset base.

Example: You spend $1000 on assets. Over a pre-determined period, you earn $100.

100/1000 = 10% ROA.

As mentioned, a higher ROA implies better asset utilization and efficient management practices.

Let's use the same example, except this time you spend $2000 for the same earnings.

100/2000 = 5%

Factors That Impact Return on Assets

In this case, you'll want to look at several factors.

• Expenditures. How extravagant were they? Did you incur any unnecessary expenses?
• Operations. Look at the efficiency of the business strategy.
• How well did the operator conduct business? This could include marketing, sales, and customer service.
• Financial health. Look at the economy, prices, customer needs, product/service quality, and other factors.

What Is a Good ROA? Understanding Return on Assets Metrics

Generally, you consider a return on assets in the 10% range good. Above this mark means excellent. Below means a poor showing. Again, remember, it depends on the industry as seen above.

An ROA below one percent implies that the company experiences operational loss. When ROA is lower than the cost of debt, which includes interest payments, the company loses money on each dollar of debt owed.

Continuous low ROA, especially below the cost of capital, leads to financial distress and, eventually, bankruptcy. Excessive debt without the ability to repay it through increased revenues or cost reductions risks a company's survival. This emphasizes the critical importance of monitoring ROA as a key financial metric.

Improving ROA with a Computerized Maintenance Management System (CMMS)

Implementing a computerized maintenance management system (CMMS) can significantly enhance a company's return on assets. CMMS software organizes maintenance management. Asset management falls under this category. Let's look at ways a quality system benefits.

• Improving asset reliability and minimizing downtime. Regular maintenance schedules and proactive asset management activities. You create lists of the types of assets, the lists for preventive maintenance (PM) tasks. These strive to keep a machine at a baseline functionality. They extend asset life, reduce unplanned downtime, and keep assets operating with greater efficiency.
• Equipment tracking. Readings to judge the "health" of the asset. These help shape PM strategy.
• Costs tracking. Maintenance denotes an expense so you want to monitor it. Inventory and labor.
• Depreciation tracking. Part of the cost includes judging when maintenance costs outweigh purchasing a new or replacement asset. This greatly benefits ROA.
• Reports. A CMMS offers plenty of reports to analyze all information about an asset. Key performance indicators (KPIs), help the maintenance team work more efficiently. Reports offer areas for improvement.

Key Takeaways on Understanding and Calculating ROA

Understanding ROA keeps you in tune with your operations. The percentage helps you analyze efficiency and expenses.

When you use a CMMS in your maintenance department, you enhance asset functionality. Training production personnel for proper maintenance and asset usage also helps bump up the ROA.

Knowing your ROA should be part of your business strategy. Using a CMMS should be part of your maintenance strategy.

For more information on Return on Assets, visit Investopedia.

For a world-class CMMS, visit Mapcon. 800-922-4336