What it means
Return on assets asks a simple question: how well is the company turning what it owns into profit? ROAA improves on the basic version by using the average of the opening and closing assets for the year, instead of a single year-end figure.
This is fairer when the business grows or shrinks during the period. To see why averaging matters, imagine a bank that doubles its loan book in the last month of the year.
A year-end asset figure would make profit look low compared with assets, even though the new assets were barely used. The average smooths this out.
ROAA is widely used for banks, where assets are mostly loans and investments. A figure of around 1% is often viewed as respectable for a bank, though the right level depends on the country, business model and economic conditions.
For other industries, such as retail or manufacturing, the normal range varies a lot with how much equipment and inventory they need. The calculation uses net income, which is profit after interest, tax and all other costs, divided by average total assets.
Analysts compare ROAA across years to spot trends and across competitors to see who uses assets more productively. A nuance is that ROAA ignores how the assets are funded.
A company that borrows heavily can show a similar ROAA to one funded by shareholders, but it carries more risk, which is why ROAA is usually read alongside return on average equity. Analysts often break ROAA into two parts to see what drives it.
Net interest margin and fee income show how much the assets earn, while cost control and loan losses show how much is kept after expenses. A bank whose ROAA falls because of rising bad debts has a different problem from one whose margin is shrinking.
In practice
Real-world examples.
Example
A community bank reports ROAA of 1.2% this year compared with 0.9% last year. Management credits better loan pricing and lower bad debts.
Example
A leasing company with $300 million of average assets earns $6 million of net income. Its ROAA is 2%, and the CFO compares it with two rivals to see whether the firm is using its fleet well.
Example
An analyst screens retailers for ROAA. She notices that a chain with large, under-used stores has a much lower figure than its neighbour, which uses smaller, busier units.
Formula
Calculation
ROAA = Net Income / Average Total Assets
Average Total Assets = (Opening Total Assets + Closing Total Assets) / 2
Worked example: A small bank earns net income of $1,500,000. Total assets were $95,000,000 at the start of the year and $105,000,000 at the end.
Average total assets = ($95,000,000 + $105,000,000) / 2 = $200,000,000 / 2 = $100,000,000
ROAA = $1,500,000 / $100,000,000 = 0.015 = 1.5%
Using only the year-end figure would give $1,500,000 / $105,000,000 = 1.43%, which understates the performance because the growth in assets happened during the year.
Compare this with a second bank that earns net income of $1,500,000 on average assets of $150,000,000. Its ROAA is 1.0%, so the first bank is using each dollar of assets 50% more profitably, which is a useful way to rank peers of different sizes.Case study
Seen in the real world.
Pinecrest Savings is a fictional bank that grew its balance sheet quickly by buying a portfolio of mortgages in the second half of the year. In this illustrative case, the board noticed that return on year-end assets dropped from 1.3% to 1.1% and feared that profitability was falling.
The finance director recalculated using average assets. With opening assets of $400 million, closing assets of $520 million and net income of $5.52 million, the average was $460 million, so ROAA was $5.52 million / $460 million = 1.2%.
The fall was real but smaller than first thought, and most of it came from the new mortgages not yet earning a full year of interest. The finance director told directors to expect the ratio to recover as those loans earned a full year of income. The board kept the strategy and asked for ROAA to be reported on an average basis in all future packs.
Watch out
Common mistakes.
- Using year-end assets instead of the average. This distorts the ratio when the balance sheet changes a lot during the year.
- Comparing ROAA across very different industries. A software firm and a bank have different asset needs, so the figures are not directly comparable.
- Reading a high ROAA as always good. It may come from taking on risky assets that could produce losses later.
Questions
People also ask.
Is ROAA the same as ROA?
ROA often uses year-end or opening assets, while ROAA specifically uses the average of the opening and closing figures.
What is a good ROAA for a bank?
Around 1% is often seen as healthy, but it varies with the country and the economic cycle.
Why do banks focus on ROAA?
Their profit depends on how well they deploy a large asset base, so a small change in the ratio has a big effect on earnings.
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