Return on Assets (ROA)

Return on assets (ROA) is an indicator, expressed as a percentage, of an organization's profitability. ROA is calculated as follows:

Net income is the total annual or annualized revenue less expenses and nonoperating gains or losses. For example, assume the following related to ABC Medical Center:

[Page 489]Using the this information, the return on assets calculation for ABC Medical Center for the year 200X would be net income of $350,000 divided by total assets of $10,000,000, or 3.5%.

Return on assets is an indicator of how well an organi-zation's invested capital is generating earnings. The higher the ROA value, the better an organization is leveraging its assets in the generation of earnings, and presumably the generation of cash.

Return on assets is an important ratio for a number of reasons. First, the ratio tells creditors and shareholders of public companies how well the organization's assets are being deployed in the generation of income. Investors look at return on assets as a key evaluation criterion for companies. However, it is important to note that return on assets varies greatly from industry to industry. For example, health care is an asset-intensive industry, relying on large amounts of buildings, major medical equipment, and other assets to generate its profits. In contrast, many service industries utilize few capitalized assets in the generation of its earnings. Even within the health care industry, return on assets can vary significantly between different types of organizations. For example, an acute care medical center generally utilizes more assets in the generation of earnings than a home health agency, which has relatively few capitalized assets.

Return on assets is also important in evaluating investment in new projects. Along with return on investment (ROI), this measure is important for companies deciding whether or not to initiate a new project. The basis of this ratio is such that if a company is going to start a project and expects to earn a return on that project, ROA is the return it would receive. Generally speaking, if the expected ROA is above the rate at which the company borrows funds or above some other predetermined hurdle rate for new investments, then the project should be undertaken; if not, then the project is rejected.