Return on Assets

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Permalink Reply by Sachidanand (Sacha) Singh on July 31, 2009 at 10:01am

If by return we mean the accounting profit then numerator should be net profit only. Denominator, I feel should be Total Assets as on last year's balance sheet, or perhaps average assets during the year.

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Permalink Reply by Andrey Kostko on July 31, 2009 at 6:17pm

From economic (actual perspective) option 1 has been using almost in every valuation scenario. Interest expense relates to a financial decision , which could not be taken under consideration for ROA adjustments.
Moreover, when you get to a Net Income level, you should deduct Interest expense and Taxes from EBIT, thus in majority of cases asset's financing is already reflected in final Net Income number

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Permalink Reply by Naresh on August 1, 2009 at 3:14am

Numerator has to be Net profit after interest and taxes to arrive at the correct picture. That is what a company is generating through its assets. If you add interest expense to the net profit or take EBIT then you may lead to wrong interpretations, particular, when you are making a decision to invest in the company or provide financing.

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Permalink Reply by David Olaogun on August 13, 2009 at 1:41pm

The second option is more appropriate in the context of ROA calculation. it is the Total income/ outstanding Loan Value (or total Asset). total income is basically income before interest repayment.

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Permalink Reply by Walter A. Paraiso on August 27, 2009 at 1:56am

I have read lot of references, and theoritically the approach are different each other. Usually, the option number 1 is the common formula, but there is an exception to the rule that if there is interest-bearing debt, the option number 2 is preferable, ROA is computed as Net Income + Interest Expense (1-Tax Rate) divided by Average Total Assets. This will measure the true productivity of assets regardless how the assets are financed.

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Permalink Reply by Manoj Gautam on September 22, 2009 at 3:14pm

Well, ROA is a measure of use of efficiency of assets by an organization, if we take argument no 2, then probably there will be some assets which will be financed through interest free loans ( unsecured loans advanced by promoters). On a serious note, you want to calculate how efficiently your capital is used irrespective of the leverage. The measure doesnt tell us about the capital structure at all, that is left to other ratios. We are more interested to know the true return potential of assets and since to generate those returns, the debt has been employed, it is always prudent to use PAT instead of adding interest expense. Capital employed need not be equal to total assets all the time, usually it always equals to net assets, so if we exclude interest component in the numerator and use net assets as denominator, that will give us ROCE instead of ROA

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Permalink Reply by Ryan Urech on September 22, 2009 at 5:53pm

Number 2 is the better choice however, you should discount the interest payment net of taxes, so the formula should be:

Net income + (interest expense *(1- tax rate)) / average total assets

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Permalink Reply by Amit Puggal on November 22, 2009 at 12:31pm

According to me, best way to look at the ROA is take into consideration the DUPOND analysis. this covers the profitability capacity and efficiency of the company. formula for this is

ROA= Net profit margin( Net Profit/sales)x Assets turnover ( Sales/Average assets)

this ratio also tell us about which factors really affects the comapany's performance.

Some people or analysts also use this ratio in different way.

According to them

ROE= Net profit margin(Net Profit/ sales) x Assets turnover ( Sales/Average assets) x Equity multiplier ( Average assets/ Average equity)


this formula covers each aspect of the company like profitability, efficiency and capital structure.

you can easily find that in some cases companies having same ROE. and may not be equally efficient, profitable and more on that leveraged. With the help of Du-pond analysis we can easily find out that which part of the company affect the performance like profitability efficiency or high debt part.

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Permalink Reply by Muhammad Asif on November 23, 2009 at 12:31am

thanks Amit for helpful explanation.

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Permalink Reply by Anand on November 23, 2009 at 6:18am

hi..

In my view, as Return on Assets measures the efficiancy of utlizations of assets in generating profits. You must choose option 1 only.

regards

Anand

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Permalink Reply by Stefan Yordanov on December 8, 2009 at 4:49pm

The idea of ROA is to provide benchmark of how a company is peforming compared to its size. Futher how it is perfoming comapred to the sources of financing is ROE.

What would be the driver behind your idea of oprion 2? It is the to add interest then you should consider also the tax shield of inetrest then you go some kind of EBIT/TA...

If a certain ration would give you better look and understaning of that what your are loking then use it, just do not mix it with that that is commonly accepted so you can skeeap the same language with the ones you communicate

Best,
SY

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Permalink Reply by T.Venkataramanan on February 1, 2010 at 8:39pm

I agree with stefan .This would be a better ratio for the measurement of asset performance.

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