Return on average assets definition

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What is the Return on Average Assets?

The return on average assets measures the efficiency with which a business utilizes its assets to generate a profit. It is most commonly used to measure the performance of financial institutions.

How to Calculate the Return on Average Assets

The return on average assets calculation follows these steps:

  1. Derive the average assets by adding together the beginning and ending book values of all company assets, and dividing by two.

  2. Divide the average assets figure into the net income generated during the measurement period.

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When to Use the Return on Average Assets

Here are five examples of situations in which it makes sense to use the return on average assets (ROAA):

  • Banks and financial institutions. In the banking industry, asset levels can vary significantly due to changes in loans and deposits. ROAA provides a clearer measure of how effectively a bank is using its assets, such as loans and investments, to generate profits over time. By using the average of beginning and ending assets, ROAA accounts for these fluctuations, giving a more accurate picture of performance.

  • Seasonal businesses. Companies with significant seasonal variations in assets, like retail businesses that stock up before holiday seasons, benefit from ROAA. For example, a retailer’s inventory levels might peak before the holidays and drop afterward. Using ROAA smooths out these spikes, allowing for a better assessment of how effectively assets are utilized throughout the year.

  • Capital-intensive industries. Manufacturing companies or utilities with large investments in machinery and infrastructure can use ROAA to assess efficiency. Since capital assets in these industries might experience fluctuations due to acquisitions or disposals, ROAA helps in evaluating performance without being distorted by temporary changes in asset levels.

  • High-growth companies. For businesses undergoing rapid expansion, assets might increase significantly within a short period due to new investments or acquisitions. ROAA helps in understanding how well these additional assets are being used to generate income, offering a more balanced view of efficiency compared to a traditional ROA calculation.

  • Mergers and acquisitions. After a merger or acquisition, asset levels can change dramatically. ROAA is useful for assessing how well the combined entity is utilizing its newly expanded asset base to generate profits. By averaging the assets before and after the merger, ROAA provides a smoother measure of post-merger efficiency and profitability.

In these situations, ROAA serves as a more reliable metric for evaluating asset efficiency, providing a balanced view of performance that accounts for changes in asset levels over time.

Disadvantages of the Return on Average Assets

There are several disadvantages to be aware of when using the return on average assets. They are as follows:

  • Negative impact on business heath. Management is usually considered to be doing a better job when it can produce a profit with a reduced asset base. However, an excessive reduction of assets can be detrimental to the health of a business. For example,  management could decide to reduce the number of days that customers are allowed to pay on credit, which reduces the investment in accounts receivable, but may also drive away some customers.

  • Calculation inaccuracy. A problem with the return on average assets is that it assumes the beginning and ending asset figures are representative of the asset levels experienced on a daily basis, which is not necessarily the case. The asset level in some industries can change substantially on a daily basis; if so, it can make sense to compile the average assets figure from the ending balance on every business day.