Nobody starts a business if they don't want to make money. Figuring out whether you're making what you should, or could, can be a challenge. Return on assets (ROA) is one way to measure success: how much income do your business assets generate for you? It's possible to have a negative ROA, but that isn't necessarily a sign of mismanagement.
The ROA Formula
Calculating return on assets is simple: divide net profits, also called net income, by total assets. Net profit is the amount left after you take out all expenses, including taxes and depreciation. If your company has $200,000 in assets and $20,000 in net income for the last quarter, the ROA is 1 percent.
If net income is in the red, ROA is negative, too. Suppose your net income for the last quarter was a $20,000 loss. Now your ROA is negative 1 percent. This doesn't necessarily mean your company is running out of money. A company can, for example, have a positive cash flow but write off a lot of revenue because of depreciation. Even major companies can have a negative ROA.
Positive or negative, big or small, ROA doesn't mean much until you compare it to the rest of your industry. Comparisons across other industries aren't productive because they're so different. In industries that require massive investments in factories or vehicles, the ROA will be lower than in industries where one laptop computer is all the tech necessary. Companies that sell retail have more assets than personal shopping services. In 2006, software companies had an average 13.1 ROA while automakers, who invest more heavily in fixed assets, had a 1.1 ROA. General Motors had a -1.8 ROA.
Comparing companies within an industry works better. If, say, the industry average is 6.5 and your company has an ROA of 8, that's a useful metric. But even within an industry, having a higher ROA or a negative ROA doesn't automatically prove which company is better. The company with a negative net income could be losing money, or it could be buying up assets that will generate profits in the future. A higher than average ROA could be a sign the company isn't investing enough in assets, which will hurt it down the line. Some companies find ways to keep their assets off the books, so it looks as if the ROA is exceptionally high. In creative fields where brainpower generates profits rather than equipment, measuring ROA may not be an effective way to evaluate companies at all.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com