Return on assets
ROA is a profitability ratio that indicates how profitable a company is relative to its total assets. The assets or capital of a company comprise debt and equity. Both types of financing are used to finance the operations of a company.
In other words, ROA measures how effectively the management is converting the money available for investments (its capital) to generate earnings. The ROA of a company will be largely dependent on its industry. Thus in comparing the ROA of two companies, it is best to do so with companies in the same industry.
ROA = (Net income) / (total assets)
For example, if company A has a net income of USD 2 million, and total assets of USD 10 million, its ROA is 20%. Take another company B, with a net income of USD 10 million and total assets of USD 100 million, it will have an ROA of 10%. Thus despite being less profitable in absolute terms, company A has a higher return on assets because it is more effective in using its assets to generate profit, probably because its management makes wise choices in allocating its resources. With a lot of capital available, it is easy to invest in different projects and generate some sort of income. The challenge is strategically allocating assets to the most profitable investments. ROA measures a manager’s ability to generate large profits with little investment.