Return on Assets (ROA)

The company point of view !

The ROA is a fundamental measure of the efficiency with which a firm manages its assets. ROA is an Economic profitability.

 

It answers the following question : How much profit the firm is generating from the use of its assets ?

• ROA does not depend upon the way the firm finances its assets
  
• Usually define ROA on a pre-tax basis to make international comparisons
  
• and to compare profitability across firms having different financing strategies

Pre-tax ROA = (EBIT / Assets) . 100

Click here to see the source of data

Starworld Group	2021	2022	2023
EBIT	478	676	1042
Assets	2250	2605	2700
Pre-tax ROA	21,24 %	25,95 %	38,59 %

If, for any reason, we want to consider the ROA after tax, the definition will be the following :

After-tax ROA= [( EBIT . (1-T)) / Assets ] . 100

"T" is the corporate tax rate.

Click here to see the source of data

Starworld Group	2021	2022	2023
EBIT	478	676	1042
- Tax 30 %	143	203	313
EBIT after-tax	335	473	729
Assets	2250	2605	2700
After-tax ROA	14,88 %	18,16 %	27,00 %

 

To show how Operating Cycle affects the Economic Profitability, ROA must be decomposed into 2 elements :

Pre-tax ROA = Return on Sales x Asset turnover

Pre-tax ROA = [ (EBIT) / Sales ] x [ Sales / Assets ]

Click here to see the source of data

Starworld Group	2021	2022	2023
EBIT	478	676	1042
Sales	2784	3341	4343
Assets	2250	2605	2700
Return on Sales	17,17 %	20,23 %	23,99 %
Asset Turnover	1,237	1,283	1,609
Pre-tax ROA	21,24 %	25,95 %	38,59 %

 

The Asset Turnover (ATO)

ATO means the Sales generated by each $ of assets
But what is important is the trend.

An improvement in the ATO :

• means a great deal of efficiency and creativity in managing and controlling the company assets

• but it may also reveal that some assets (especially fixed assets) are not renewed, which may create some long term efficiency problems.

A deterioration in ATO :

• is a signal of poor asset management or
• is the result of an ambitious program of asset renewal or
• an aggressive policy of acquisitions

In some companies, sales may not be the best indicator of activity

Some financial analysts will then prefer the concept of Added Value : defined as the production of the period minus the goods and services acquired by the firm outside and used during the same period.

Currents assets, especially Inventories and Accounts Receivable, may be very heavy. They can sometimes represent 50 % or more of total assets. It is therefore crucial to manage and control these assets efficiently.

So, Operating Managers can impact the company ROA

• either by improving the Profit margin [ EBIT / Sales ]

through Cost Control or Revenue increases

• or by improving the Asset turnover [ Sales / Asset ]

through a better capacity utilization or a more efficient WCR management

Sources :

Interpreting and using financial statements, 1999, Marc Bertonèche, Ph. D. in Finance from the Northwestern University, Professor at the Bordeaux University and at Sciences-PO Paris, Visiting Professor at Harvard Business School and Oxford University.

© ECOFINE.COM, Bernard Jaquier, Professor Emeritus & Dr Honoris Causa, Lausanne, SWITZERLAND, 2024