Return on assets (ROA) is net income divided by average total assets, expressed as a percentage. It says how many cents of profit a period produced for every dollar of assets the business held while producing it. The two inputs are measured differently, net income over a stretch of time and total assets at a single date, which is why the denominator is normally an average of two balance sheets rather than one.
The Return on Assets Formula, Term by Term
return on assets = net income / average total assets x 100
average total assets = (beginning total assets + ending total assets) / 2No accounting standard sets this formula. It is derived from two statements the standards do govern, so the part worth getting right is where each input is read off.
Net income is the bottom line of the income statement for the period, what is left after the cost of what was sold, operating expenses, interest and income tax expense. The order those subtractions run in is set out in net income, and it is the last line rather than any subtotal above it, the point multi-step income statement works through.
Total assets is a reported caption rather than a figure the reader assembles. Regulation S-X runs the asset side through cash, receivables, inventories and the rest, then closes it at caption 18, total assets (17 CFR 210.5-02). That is the opposite of the denominator in equity multiplier, which has no caption of its own and has to be footed. What qualifies to sit inside the caption is the element question worked through in assets and liabilities.
Why the Denominator Is Averaged
Pairing a whole period’s profit against a single date’s balance charges the year against whatever the business happened to hold on the last day of it. Net income covers the span while total assets is stated at a date, the split balance sheet vs income statement sets out, and a two-point average of the opening and closing balances is the usual repair. The SEC’s own walkthrough of that average, taken on the inventory turnover ratio, is set out in cash conversion cycle.
Two things follow. The averaged version cannot be built from one balance sheet, because the opening figure is the prior period’s closing figure, so a client with no prior-year comparative has no average to compute. And an end-balance version is also in use, so the same two statements produce a different percentage under each convention, which means a return on assets quoted without saying which denominator produced it cannot be set beside another one.
A Worked Example
Say a client’s statements for a year carry the figures below, with the asset base growing across the year.
Net income for the year 84,000
Total assets, beginning of year 1,000,000
Total assets, end of year 1,400,000
average total assets (1,000,000 + 1,400,000) / 2 = 1,200,000
on average assets 84,000 / 1,200,000 = 7.0%
on ending assets 84,000 / 1,400,000 = 6.0%
on beginning assets 84,000 / 1,000,000 = 8.4%One year, one set of statements. The average and the end balance sit a full point apart, and the reading on the opening balance sits further away still. The faster the asset base moves across the year, the wider that spread gets, so a client who buys a building in December changes the reported return without earning another dollar.
Where the Ratio Sits in the DuPont Chain
The DuPont decomposition splits a return into the pieces that produced it, and return on assets is its first two factors multiplied together. Net profit margin is net income over revenue, asset turnover is revenue over total assets, so revenue cancels and what is left is net income over total assets. Multiply that by the equity multiplier, total assets over equity, and assets cancel too, leaving return on equity. The full three-factor chain is set out in equity multiplier.
The cancellation only works while every factor uses the same asset figure. A chain built on average assets and a return on assets computed on the closing balance do not reconcile, and the gap looks like an error in the margin or the turnover when it is neither.
What Return on Assets Is Not
Return on Equity
Return on equity divides the same numerator by shareholders’ equity, so it reads the return on the owners’ slice rather than on everything the business holds. The gap between the two denominators is itself a ratio, the equity multiplier, and return on assets multiplied by it gives return on equity. Borrowing raises the multiplier, so it can lift return on equity without lifting return on assets at all.
The Accounting Rate of Return
The accounting rate of return is average annual accounting profit over the investment made in a project, and it is also known as the return on investment (ACCA, Accounting rate of return). That loose use of ROI is where the two get tangled. One appraises a single project across its whole life, and return on assets reads a whole business over one closed period.
The Debt to Asset Ratio
This one shares the asset base and nothing else, and it reads total assets at a single date rather than as an average across the period. Debt to asset ratio analysis puts liabilities over total assets, so it asks who funded that base, while return on assets asks what the base earned.
Common Questions
There is no benchmark that holds across businesses. As a general rule, desirable ratios vary by industry (SEC, Beginners’ Guide to Financial Statements), and the denominator is why that caution bites harder here than on a margin. An asset-heavy business carries a larger denominator for the same work, so a reading means something only against businesses holding a comparable asset base, and only against figures built on the same convention.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a trial task lets a firm grade a real block of its own close work before a client’s ratios depend on it.
