Hey I'm James and today on Accounting Stuff we're talking Return on Assets or 'ROA' what does it mean?
How can we calculate it? How can we improve it? All will be revealed but first a quick shout
out to all my channel members you know who you are thank you for your support
What does Return on Assets mean? Let's think about this for a moment assets are the stuff
that a business owns and return means yield or profit so essentially Return on Assets tells
us how much profit a business generates from the stuff it owns and the technical way of saying this
is Return on Assets or 'ROA' is equal to net profit divided by total assets this is a profitability
ratio that we usually express as a percentage whenever that's the case remember to multiply
by 100 as usual you can find this formula on my profitability ratios cheat sheet the link is in
the description but hang on a sec there's a problem here net profit is the bottom line
financial gain generated over a period of time whereas total assets are the stuff that a business
owns at a point in time to compare like with like we can use average total assets
and what are average total assets? Closing total assets plus opening total assets divided by two
I'll show you how this works in a second where can we find net profit and total assets?
net profit belongs in the income statement this is the financial statement that summarizes a
business's revenues and expenses over a period of time net profit is on the bottom line it's
the net financial gain left in the business after deducting all expenses total assets live
in the balance sheet this is another financial statement that gives us a snapshot of a business's
assets, liabilities and equity at a single point in time this is a comparative balance sheet because
we have two columns one for the current year and one for the previous year the numbers we're
looking for can be found here and here closing total assets at the end of the current year
and opening total assets which are the same as last year's closing total assets drumroll please
How do you calculate Return on Assets? It's time for an example scoop, muck and dizzy contractors is
a company that designs and builds infrastructure all across the sunflower valley and here
are their financial statements we've got their income statement for the current year and their
comparative balance sheet we can use these to work out SMD Contractors Return on Assets remember
Return on Assets is equal to net profit divided by average total assets multiplied by 100 and
average total assets are equal to closing total assets plus opening total assets divided by two
so let's do this we'll start with net profit this can be found on the bottom line of SMD Contractor's
income statement right here 45 million dollars for the year ended 31st of december let's pick up this
number and pop it into our equation opening and closing total assets live on the balance sheet
and here is SMD Contractors comparative balance sheet their closing total assets at the end of
the current year were 870 million dollars and at the end of last year they were 930 million dollars
let's chuck these numbers into our ROA equation closing total assets of 870 million dollars
and opening total assets of 930 million dollars we can find average total assets by adding these
together and dividing by two 870 million plus 930 million is 1.8 billion dollars and if we divide
that by two we can see the SMD Contractors average total assets for the year were 900 million dollars
if we divide their net profit of 45 million by their average total assets of 900 million dollars
and multiply by 100 then we can see that SMD Contractors had an 'ROA' or Return on Assets
of 5% but what does this mean? Why is Return on Assets important? Well from an investor's point
of view it's great for making comparisons ROA tells us how efficiently a business used its
assets the stuff that it owns to generate profit we can compare the Return on Assets from different
businesses in similar industries for example SMD Contractors have an 'ROA' of five percent
but a rival construction company had an 'ROA' of seven percent for the same period B&W were
able to generate two extra cents of net profit from each dollar of assets they own the bigger
the better if that's the case how can a business improve its Return on Assets? Well they need to
increase their net profit relative to their total assets but that's easier said than done a better
way to look at this is to split Return on Assets into its core components so 'ROA' is equal to net
profit divided by revenue multiplied by revenue divided by total assets which means Return on
Assets equals Net Profit Margin multiplied by the Asset Turnover Ratio as you can see there are two
components to this a business can increase its 'ROA' by improving its Net Profit Margin and it can
achieve that by raising its sales prices, changing the sales mix to focus on higher margin products
or services, or it could reduce its overheads to improve its operating efficiency there are plenty
of options and I made a whole video on this topic not too long ago but a business can also increase
its 'ROA' by improving its Asset Turnover Ratio its efficiency at earning revenue from its assets I
plan to cover this in a future video so stay tuned thanks for watching I'll see you in the next one!