What Is Return on Asset (RoA)?
In simple words, ROA aka Return on Assets helps in evaluating how effective is the companies ability to use its assets in order to create profits. In other words, ROA is a financial ratio telling about the companies management efficiency at positioning its various productive and non productive assets.
Keep in mind higher the Return on Assets (ROA) better it is for the company. Needless to say ROA is compared with the other companies in the same industry (Peers) and is also observed over a long time frame. That is to say look for atleast last 5 year ROA to better check the consistency for any company.
How Return on Asset (RoA) Is Calculated?
The formula use to calculate return on asset (ROA) is given below:
RoA can be calculates as = [Net income + interest*(1-tax rate)] / Total Average Assets
In above equation Net Income is also referred as Profit After Tax which is also refer to as Net earnings or net profit or the bottom line of the company.
Just to let you know PAT numbers and interest also known as finance cost are accessible in Profit and Loss statement where as assets is in balance sheet both can be found in any companies annual report.
Let us understand how to calculate ROA through a simple example,
For understanding purpose I have taken Tata Motors Limited (TML) Annual report, you can download Tata Motors Limited annual report here or even can get it from its website.
Standalone Financial statements represent the company’s standalone numbers/ financials and do not include its subsidiaries’ financials.
Whereas, the consolidated numbers include the companies (i.e. Standalone financials) and its subsidiaries financial statements.
Hence you should look through the consolidated financial statements as it represent the company’s financial position better.
Let us look at the P&L statement (this is half part covering only PAT) of Tata Motors Limited (TML) .
As you can see from the snapshot above, to arrive at the profit after tax (PAT), we need to deduct all the applicable tax expenses from the PBT. Hence, TML has total profit and loss for FY21 of about Rs.(-13,451.39). FYI, the number in bracket are negative.
If you see under expenses there is a line item mentioned as finance cost, this is what is called as interest which currently stands at Rs.8097.17 crores. If you see the above mentioned formula to calculate the ROA, After Net Income is interest *(1- tax rate).
So what does interest *(1- tax rate) mean? Well, think about it, the loan taken by the company is also used to finance the assets, which in turn is used to generate profits.
So in a sense, the debtholders (firms who have given a loan to the company) are also a part of the company. From this perspective, the interest paid out also belongs to a stakeholder of the company.
The company also benefits in terms of paying lesser taxes when interest is paid out; this is also called as ‘tax shield’. Therefore, we need to add interest (by accounting for the tax shield) while calculating the ROA.
Here tax rate means the corporate tax charged by government towards company in an given financial year. Which ranges currently charged at 30%. But there is a problem as it is a consolidated financial statements, this means the taxes are included for Tata motors and its subsidiaries.
If we check the associated note number in the financials statements also called as schedules you will see how much tax rate has been charged, take a look at note number 22 as mentioned in P&L statement next to income tax expense, which explains more about taxes and how it has been charged, i.e. at what rate.
Take a look at below snapshot:
The above notes shows you the PBT (profit and loss before taxes) which is at Rs.(10,474.28)cr and total tax charged Rs. 2,541.86 cr.
Also check out the below image to know the income taxes rates applicable on TML.
Read the note as it says the JLR which is a subsidiary has been charged at 19% where as TATA Motors India has been charged at the current income tax slab which was 30%.
So, even if we take an average for both this comes close to 24.3%, another way is to find out 24.3% of 10474.28 which will give you the taxes applicable of Rs.2,541 cr.
A few points up and down does not make much of difference hence acceptable, Although you do not need to do this incase the company is purely domestic and does not hold any subsidiaries outside India. Just know the CIT charged for the year.
Now, if check the Balance sheet will get the TML Assets, checkout the image below:
As you can see from above snapshot, the total assets for FY21 is Rs.343,125.80 and FY22 is at Rs.322,121.26 cr, however the formula for ROA says we need to take average for both i.e. average of total assets, hence will add both and divide it by 2 = Rs.3,32,623.53 cr
Now the whole equation is complete.
RoA = [Net income + interest*(1-tax rate)] / Total Average Assets
Net Income = -13451.39
Interest/Finance Cost = 8097.17
Tax Rate = 24%
Total Average Assets = 332623.53
Hence ROA = [-13451.39+8097.17(1-24%)]/332623.53 = -2.19%
This means TML has a negative ROA and its assets are not able to create profits for the company for FY21, moreover pandemic added the fuel required fuel to skew it down the stocks to new low level last year, although it have regained much now due to the last half year performance.
However as said above do look for last few year data to get the correct picture and also know the same about the peers. In the case of TML, it would be Maruti and Mahindra. Also do checkout the quarterly reports to stand at better position while investing.
So checkout their respective ROA, you can either calculate the same from its AR or can used the data which is available on any stock analysis websites.
But remember, doing it from AR will be more good as sometime you will find the data on certain website mismatched. Also, keep in mind higher the Return on Assets (ROA) better it is for the company.
I hope now you have the basic understanding of what is ROA and how it is calculated.
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