What is Return on Average Assets (ROAA)?
Return on Average Assets (ROAA) is a crucial metric that helps assess the profitability of a firm’s assets, predominately used within banks and other financial institutions to judge financial performance. While sometimes used interchangeably with Return on Assets (ROA), the key distinction is that ROAA utilizes average assets over a given period rather than current assets.
Key Insights
- Return on Average Assets (ROAA) illustrates how well a company employs its assets to generate profits, particularly useful when comparing like companies within the same industry.
- ROAA’s formula incorporates average assets to reflect significant fluctuations in asset balances over the period being analyzed.
- Firms requiring heavy upfront investment in equipment and other assets tend to exhibit a lower ROAA.
Understanding Return on Average Assets (ROAA)
ROAA measures a company’s efficiency in utilizing its assets and is especially useful when evaluating peer companies within the same industry. Unlike Return on Equity (ROE), which assesses the return on invested and retained dollars, ROAA focuses on the return derived from the acquired assets using those dollars.
Industries with high capital investment usually showcase a lower ROAA. Generally, a ratio of 5% or higher is regarded as good. ROAA is computed by dividing net income by average total assets, expressed as a percentage.
ROAA formula:
ROAA = (Net Income) / (Average Total Assets Where: Net Income = Net income for the period Average Assets = (Beginning Assets + Ending Assets) / 2
Net income, found on the income statement, offers insight into a company’s performance over a specified period. Analysts often refer to the balance sheet for assets. Differently from the income statement showing growth over time, the balance sheet represents a snapshot at a specific point in time. To ensure more accurate measurement, analysts adopt average assets since it accounts for year-round balance fluctuations, thereby providing a comprehensive measure of asset efficiency for the period of analysis.
Practical Example
Imagine Company A registers $1,000 in net income at the end of year two. For the calculation, an analyst uses the asset balance from the end of year one and averages it with the asset balance at the end of year two.
Company A’s assets at the end of year one amount to $5,000, rising to $15,000 by the end of year two. The average assets are thus ($5,000 + $15,000) / 2 = $10,000. Consequently, by taking $1,000 in net income and dividing it by $10,000, the ROAA calculation renders a return of 10%.
Using the beginning balance solely, the ROA would be 20%, whereas ending asset balance solely results in a ROA of 6%. ROAA, using average assets, rationalizes these discrepancies, paving the way for a more stable measurement.
Distinction Between ROAA and ROA
When utilizing average assets, ROA and ROAA become identical. Differences emerge when analysts use only the beginning or ending assets. ROAA, using average assets, presents a more accurate portrayal of company performance over the accounting period by smoothing out volatile asset changes.
What are Average Assets?
Average assets, often reported on a company’s balance sheet over an accounting period, represent the midway value between beginning and ending assets. Typically calculated as the sum of beginning assets and ending assets divided by two, this method accounts for day-to-day asset value fluctuations, delivering a more reliable metric.
How ROAA Differs from Return on Total Assets (ROTA)
While ROAA uses net income in the numerator, Return on Total Assets (ROTA) employs EBIT (earnings before income and taxes) in the numerator. Both metrics, however, use average total assets in the denominator.
Related Terms: Return on Assets, Return on Equity, Net Income, Balance Sheet.
