RETURN ON ASSETS (ROA) | Financial Ratios - YouTube

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!