Return on Asset: Core Indicator on Your Company Efficiency

When running a business, you need to balance between achieving sales goals and earning profits. Financial ratios, such as Return on Assets (RoA), act as a report card, showing how efficiently a company uses its resources to boost productivity and profits.

RoA is a profitability ratio that indicates how well a company turns its assets into profits, offering insights into potential future performance based on past income.

This metric is essential for evaluating overall business efficiency, particularly in terms of returns on investment. By understanding RoA, companies can gain a clear picture of their operational effectiveness and make informed investment decisions.

Modern asset management software can streamline this process by managing assets and calculating ROI, aiding in more efficient asset utilization.

Understanding Return on Asset 

Return on Assets is a financial ratio that shows how well a company uses its assets to generate profit. Expressed as a percentage, RoA indicates how effectively a company turns its assets into earnings.

A higher RoA suggests better efficiency in using resources, while a lower RoA may signal areas needing improvement. RoA is crucial for evaluating operational efficiency because it reveals how effectively a company uses its assets to produce and sell goods.

A high RoA indicates that assets are well-utilized in generating profit, highlighting efficient management and productive operations. Conversely, a low RoA may point to inefficiencies or the need for operational adjustments.

For investors, RoA is essential in assessing the return on their investment. A high RoA signifies strong performance and effective asset management, making the company a more attractive investment. It reflects the company’s ability to generate returns on invested capital, guiding investors in their decision-making process.

Ways to Calculate Return on Asset

In order to see how well a company is using its assets to make money, you need to calculate the Return on Assets (RoA). RoA shows how efficiently a company turns its assets into profit. Here’s a simple guide on ways to calculate RoA: 

1. Steps in calculating Return on Asset

To find out how efficiently a company is using its assets, you need to calculate its Return on Assets. Below is the Return on Asset formula:

RoA = (Net income after tax/ Average total assets) x 100%

The higher the RoA value, the better it is for the company. This value shows how well the company is earning money from all its assets. For example, if Company X has a net income of ₱15 million and total assets worth ₱50 million, you can use the formula to calculate RoA:

RoA = (15,000,000 / 50,000,000) x 100% = 30%

This means Company X is earning a 30% profit on its assets, indicating that it is highly efficient in managing the assets it owns. The higher the percentage, the greater the efficiency in utilizing those assets.

2. Steps to figure out gross profit

Then, to determine the net income needed for the RoA calculation, you first need to figure out the company’s gross profit. Gross profit is the amount left after subtracting the cost of goods sold (COGS) from total revenue. Here’s the formula to calculate gross profit:

Gross profit = Net income: Cost of goods sold (COGS)

Gross profit gives you a clear view of how much money the company makes from its core business activities before other expenses like taxes and operating costs are deducted. Once you have the gross profit, you can proceed to calculate net income and then use it in the RoA formula to measure overall asset efficiency.

Imagine a local bakery in the Philippines called “Panaderia ni Juan” sells traditional Filipino breads. 

• Total Net Income: ₱1,000,000 (from selling various types of bread)
• Cost of Goods Sold (COGS): ₱600,000 (includes costs for flour, sugar, and other ingredients)

To calculate the gross profit, you use the formula:

Gross profit = Revenue – Cost of goods sold (COGS)

Applying the numbers:

Gross profit = ₱1,000,000 – ₱600,000 = ₱400,000

So, Panaderia ni Juan’s gross profit is ₱400,000. This means the bakery earned ₱400,000 from selling bread after covering the direct costs of ingredients and production. This gross profit figure helps the bakery understand how well it is doing in its core business activities, before accounting for other expenses like rent, salaries, and utilities.

What Is a Good Return on Asset?

A Return on Assets of over 5% is generally seen as a good indicator of how well a company is using its assets to generate profit. When RoA exceeds 20%, it is considered excellent.

However, it’s crucial to compare RoA figures among companies within the same industry. This is because different industries have varying asset requirements and operating models. For example, a software company usually has fewer physical assets compared to a car manufacturer.

As a result, the software company’s RoA might appear higher simply because it doesn’t have as many assets on its balance sheet. In contrast, a car maker, which has significant investments in machinery and factories, might have a lower RoA.

This doesn’t necessarily mean it’s performing poorly; it just reflects the high cost of its assets. Therefore, when evaluating RoA, always consider how it compares with similar firms in the same sector to get a true picture of a company’s performance.

In simple terms, while a higher RoA is better, it’s essential to understand the context and industry norms to accurately assess how well a company is managing its assets.

The Key Benefits of Using Return on Assets 

Every company wants to make a profit, and so do shareholders and investors. Because both the company and its investors share the same goal, financial information like the Return on Assets ratio is crucial for both management and investors.

Here’s how RoA can benefit your company:

1. Efficiency Analysis: Management can use RoA to assess how effectively the company is using its capital for production and sales.
2. Competitor Comparison: Companies can compare their RoA with competitors to see how they stack up. This helps identify strengths and weaknesses.
3. Division Performance: By looking at RoA, the company can evaluate the performance and productivity of different divisions, helping to manage and improve each one.
4. Product Profitability: RoA helps in assessing how profitable different products are. This lets the company decide which products to focus on and which ones to adjust.
5. Corporate Planning: RoA is useful for making strategic decisions, such as business expansion. It’s also valuable for investors to understand how well their money is being used to generate profits.

Potential Pitfalls and Consideration 

One big issue with Return on Assets is that it doesn’t work well across different industries. For example, a retail store and an oil company have very different types of assets, so comparing their RoA directly can be misleading.

Also, the basic RoA formula might not fit all companies, especially banks. Banks have their assets and liabilities valued differently than other companies, which makes RoA more accurate for them.

For non-bank companies, you might need to adjust the RoA formula to deal with interest costs. Even with its limitations, RoA is still useful for understanding how well a company uses its assets to make money. However, it should not be the only measure you use.

It’s best to look at RoA along with other financial ratios to get a fuller picture of a company’s performance. This way, you can make better-informed decisions.

Practical Tips for Improving Return on Asset

Improving Return on Asset shows that you’re managing your assets well and helps strengthen your company’s financial health. Whether you have a small local business or a large corporation, increasing RoA can greatly enhance your profitability and efficiency.

To get the best results, it’s important to consider the unique challenges and opportunities in your local market. Here are some simple tips to help you improve your RoA and boost your company’s performance:

1. Optimize Asset Utilization: 

To make the most of your assets, start by improving how you manage them. One effective way is to streamline your inventory management.

Implementing efficient inventory practices ensures that you only have what you need, reducing excess stock and storage costs. For instance, using asset management software like HashMicro’s can help you manage your company’s asset efficiently and integrated.

The software could help the company in optimizing asset usage, lessened downtime and increase operational efficiency. This means you can reduce waste and keep your operations running smoothly, leading to better asset utilization and improved RoA.

2. Use Technology to Manage Assets Better

Technology can significantly enhance how you manage your assets. Consider using asset management software to track and optimize asset performance.

Such software provides real-time insights, enabling you to make informed decisions about asset utilization and maintenance. By utilizing this technology, you can streamline asset management processes, reduce operational downtime, and extend the lifespan of your assets.

Additionally, it helps you identify inefficiencies and create areas for improvement, ultimately leading to a better Return on Assets. This proactive approach not only saves costs but also boosts overall productivity and profitability.

Conclusion

Improving your Return on Assets (ROA) shows how effectively your company uses resources to generate profit.

Strategies like optimizing asset use and leveraging technology can help both small businesses and large corporations improve their ROA, streamline operations, cut costs, and increase profitability. However, ROA should be assessed alongside other financial metrics for a full performance picture.

To simplify asset management, try HashMicro’s Asset Control Software. Ideal for industries like manufacturing and construction. It reduces downtime, optimizes usage, and improves overall efficiency. Experience its benefits by trying HashMicro’s free demo today.