The return on assets (ROA) formula measures the profit a business generates from its total assets. By working out your ROA, you’ll have a good idea of your business’s financial health, enabling you to identify and address potential risks and opportunities.
Understanding the ROA formula
“The ROA formula is net income divided by the net assets of a business,” explains Nishi Patel, Managing Director at accountancy firm N-Accounting. “Net Income in this context is essentially the net profit minus interest costs. Net assets are the total balance sheet, which includes liabilities like loans.” The ROA formula is as follows:
ROA = Net Income / Total Assets
This formula helps give business owners an idea of how effectively their company is utilising its resources. Expressed as a percentage, a lower ROA is indicative of poor asset utilisation, whereas a higher ROA may illustrate a more profitable company relative to its assets.
ROA example
If Company A reports profits of £50,000, and has total assets worth £400,000, it would calculate its ROA by dividing its profits (£50,000) by its assets (£400,000). This would result in 0.125, or an ROA of 12.5%. This figure could suggest that Company A is generating fair profits relative to its assets base. This could be a sign of operational rigidity and strategic asset management.
The benefits of using the ROA formula
The ROA formula is particularly helpful when considering the opportunity cost of certain decisions within a business. “By comparing what this ratio would look like under different circumstances," like purchasing new equipment, for example, or expanding operations, "the best option can be selected,” says Patel.
Alcohol alternative business IMPOSSIBREW®, founded by Mark Wong in 2021, creates alcohol-free beers brewed with a proprietary blend of natural nootropics and adaptogens. Wong says the ROA formula has been crucial in helping him make better business decisions.
“It helps us gauge how efficiently we're using our assets to generate profit,” says Wong. “As a fast-growing startup in the competitive beverage industry, understanding our ROA allows us to assess our operational efficiency and make informed decisions about resource allocation.” He adds that it’s particularly valuable when comparing IMPOSSIBREW performance against industry benchmarks or its historical data.
“The ROA formula helps us identify areas where we can improve asset utilisation, whether it's optimising our brewing equipment, managing inventory more effectively, or scaling our operations,” says Wong. “This metric is also important for attracting investors, as it demonstrates our ability to generate returns from our assets.
Wong has used ROA when raising funds and to measure potential profits from new product launches and market expansion.
“It’s been instrumental in our fundraising efforts. When we raised £750,000 through crowdfunding, our strong ROA helped demonstrate our efficiency to potential investors,” says Wong. “When planning our international expansion, we’ve analysed the expected ROA to ensure we're making sound investment decisions.”
IMPOSSIBREW has also used the ROA formula to compare the performance of different product lines, helping it allocate resources to the most profitable areas of its business.
“This has been particularly useful as we've expanded our range with limited edition brews and merchandise,” adds Wong.
What makes for a 'good' ROA ratio?
A 'good' ROA will vary across industries, company size and economic conditions. However, generally speaking, an ROA of around 5% may be considered ‘good’, and anything higher than that would be considered better; the higher the ROA, the better you're utilising your assets. This generally correlates with better cash flow because efficiently managed assets (like inventory and receivables) tend to convert into cash more quickly.
You can add to your cash flow management tools with an American Express® Business Gold Card, which comes with payment terms of up to 54 days1. Wong says that the Card has helped IMPOSSIBREW to manage its cash flow effectively.
When to exercise caution with ROA
While ROA can be a powerful tool for understanding your business's efficiency and profitability, Wong adds that it’s important to remember that it can vary significantly across industries. It’s vital, therefore, to benchmark your business against similar companies in the same sector.
“Don't focus solely on improving ROA at the expense of other important metrics,” says Wong. “For instance, we balance ROA with measures of customer satisfaction and product quality. Ensure you use ROA in conjunction with other financial metrics for a comprehensive view of your business's health. And don't be afraid to dig deeper - analyse the components of ROA (profit margins and asset turnover) to identify specific areas for improvement.”
Patel adds that the ROA formula is valuable when comparing businesses of a certain size within the same industry, and when executive teams act responsibly and predictably. Risks when using the formula can arise from how it rewards short-term focus over long-term business health; for example, it can be influenced by temporary changes in net income or assets, making it less reliable over the long term.
“The formula also penalises businesses for sacrificing profits to invest in growth, such as when they have to expand their team or spend on marketing,” he says.
Patel adds that companies should exercise caution when setting more generalised ROA benchmarks. It also shouldn’t be compared across industries, so it can be misleading when comparing businesses in different sectors. “An equipment-heavy business like a haulage company will have a much lower cost ratio than a services business like a marketing firm,” he says.
“This is especially the case when dealing with the procurement of ingredients for, and research and development of our proprietary blend, as well as for managing payment terms involved in our performance marketing spend,” he says.
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you’d prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.