Financial analysis answers many questions, but one of the most pressing is: How efficiently are our assets generating profit?
While liquidity and cash flows are vital metrics, profitability—measured through profitability ratios like return on assets (ROA)—is crucial for assessing your company’s financial health. A strong ROA indicates your business is efficiently turning its assets into income.
Related: How to Use Profitability and Margin Ratios
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DOWNLOAD NOWReturn on Assets (ROA) Ratio
One of the most essential ratios is return on assets (ROA), which is taught in the online course Strategic Financial Analysis by Harvard Business School Professor Suraj Srinivasan. ROA reveals the percentage of profit generated for every dollar invested in your company’s assets.
It measures your organization’s income relative to its assets, including cash, inventory, and manufacturing equipment.
“ROA simply shows how effective your company is at using those assets to generate profit,” says Joe Knight, author and co-owner of the Business Literacy Institute, in the Harvard Business Review.
This simple “bang-for-the-buck” approach highlights why ROA is a widely used measure of business efficiency.
The ROA Formula Breakdown
The ROA ratio compares your company’s net income to its assets. Here’s the formula:
ROA = Net Income / Assets
- Net income: The profit remaining after all expenses have been paid
- Assets: Resources that have monetary value or can be converted into cash, such as property, inventory, equipment, investments, and cash reserves
For example, let’s say your net income for the year is $325, and your assets total $5,264. You’d calculate ROA as follows:
ROA = $325 / $5,264 = 0.0617 = 6.17%
This means your business earns 6.17 cents in net income for every dollar invested in assets.
Why Do Companies Use ROA?
Like most profitability ratios, ROA is used to assess your company’s efficiency by comparing its performance over time or against competitors. While business leaders may find ROA helpful for internal analysis, Knight says it’s a critical component for investors and banks to consider when evaluating a company’s financial viability and risk.
“[ROA] is a good indication of whether the company is even capable of generating a return that is worth whatever risk the investment may entail,” Knight explains in the Harvard Business Review.
What’s Considered a Good ROA?
While higher profitability ratios are generally better, ROA varies by industry. For example, banks and financial institutions often have lower ROAs because their assets—primarily loans—earn relatively low profit margins.
In contrast, tech companies often have higher ROAs because they generate more revenue with fewer physical assets. Even in industries where a high ROA is typical, an above-average ROA could signal a lack of reinvestment in assets, potentially jeopardizing long-term growth.
To assess whether your business’s ROA is healthy, compare your performance against industry benchmarks and historical trends.
Return on Assets (ROA) vs. Return on Equity (ROE)
ROA and return on equity (ROE) are closely linked:
- ROA measures how efficiently your company generates profit from its assets
- ROE shows how efficiently it generates returns for its shareholders
Equity is what remains for shareholders after subtracting liabilities from assets, making ROE a profitability measure that excludes debt and shows how effectively shareholder investments are being utilized.
By analyzing ROA and ROE together, you can see how much debt impacts profitability. A large difference between the two suggests your company is using significant debt to amplify returns.
ROE can be calculated with the following formula:
ROE = Net Income / Equity
Net income can be found on a company's income statement, while assets and equity are reported on its balance sheet. Income statements reflect financial performance over a fiscal year, while balance sheets present a snapshot of a company’s capital structure at a specific time.
Related: How to Calculate Return on Equity (ROE) and Why It Matters
Because of this, Knight recommends in the Harvard Business Review using average yearly assets or equity for a more accurate denominator. Average assets and average equity are calculated similarly: Add the beginning of year (BOY) and end of year (EOY) values, then divide by two.
Average Assets & Average Equity = BOY + EOY / 2
While ROA and ROE are useful measurements, they should be used alongside other metrics, including net profit margin and the DuPont formula, to gain a comprehensive view of financial health.
Measuring Profitability with ROA
Profitability is a driving factor in many business decisions. By applying the ROA formula, you can gain deeper insights into how your company leverages assets to drive profits. ROA, ROE, and other profitability ratios will strengthen your financial analysis and provide investors with reliable data.
If you want to get a deeper understanding of ROA and other essential profitability analysis methods, consider taking an online course, such as Strategic Financial Analysis. It offers interactive exercises, real-world examples, and access to a global network of engaged professionals to reinforce and accelerate your learning.
Ready to take the next step? Explore Strategic Financial Analysis—one of our finance and accounting courses—to learn how to leverage financial insights to drive strategic decision-making. If you want to get a jumpstart, download our free financial terms cheat sheet to strengthen your financial fluency.
