ROA is known as the correlation index of profitability with the company’s financials. Through the ROA index, users will know the efficiency when using assets to make a profit. So what is ROA? How is the formula calculated? What does this indicator mean?
Table of Contents
What is ROA?
ROA is an acronym for Return on Assets, it is an indicator of the rate of return on assets. This index is the ratio of profit to assets put into production and business, assessing the efficiency of using enterprise assets.
Meaning of ROA
The meaning of ROA is how much profit a business invests in assets with 1 dollar of capital. The higher the ROA, the higher the efficiency in using assets of the business.
ROA formula and example
ROA will be calculated according to the following formula:
ROA = Profit after tax/Total assets.
Example of ROA . formula
An example for you to have a clearer picture of ROA is:
Company A has an expected net income of $1 million, and its total assets are now $5 million. This asset has been declared between equity and debt. So now the formula to calculate ROA is: 1:5 x 100% = 20%.
However, if company B also has the same income with total assets of more than 10 million USD, ROA is also different. Company B will then have an expected ROA of 10%. If you put the comparison table of companies A and B, it will be more effective to turn investments into profits.
How much ROA is good for business
ROA is an important metric like ROE, the relationship of ROA and ROE is through the debt ratio. The less debt the better, the better when debt/equity < 1. According to international standard ROE > 15% is a company with sufficient financial capacity. Then ROA > 7.5%.
Even so, it is necessary to consider this relationship for at least 3 years or more, if the business maintains ROA>=10% and lasts at least 3 years, it is a good business. The increasing ROA trend shows that the business uses assets more efficiently.
ROA > 7.5% + ROA increasing + Maintain at least 3 years.
See also: What is the accounts receivable turnover? Calculation and specific meaning
What is ROE?
ROE stands for Return on Equity, which is a measure of the return on equity. ROE is the ratio of profit to equity that a business uses in business activities to evaluate the efficiency of using capital.
Meaning of ROE
ROE means 1 dollar of capital that a business spends to serve its activities and how much profit it makes. The higher the ROE, the more efficient the company’s capital is.
ROE formula and example
The ROE can be calculated using the following formula:
ROE = Profit after tax/Equity.
Analyzing the link between ROA and ROE
The link between ROA and ROE is shown by the formula for calculating financial leverage, specifically as follows:
Financial leverage = Assets / Equity = ROE/ROA.
Therefore, it can be seen that ROA and ROE are closely related, directly affecting the performance of the business. To better understand the correlation of ROA and ROE, we should rely on the Dupont analysis model.
The Dupont model is as follows:
ROE = ROA * Financial leverage = ROA * Total assets/equity = ROA * (1+Total debt/equity).
Total Assets = Total Equity or (Total Debt + Equity).
It can also be deployed into the coefficient below to see that ROE is calculated based on the coefficient of net profit margin, financial leverage, and asset utilization efficiency.
ROE = (EAT/Revenue) * (Revenue/Total Assets)*(Total Assets/Equity).
The change of ROE can be seen due to many factors on profitability of revenue (interest, tax rate, ability to control costs, …) ability to use assets (ability to generate income). income from using capital to finance assets in production and business, the ratio of using debt.
Conclusion
Hopefully with the above answers of Filipinance.com about what roa is, will help you get specific information on this issue, through which you can easily apply the ROA calculation formula. If you have any questions, please leave a comment below to be answered soon.
See also: What is monetary policy? The role of monetary policy in the economy
