How return on assets works

Return on assets asks what the whole balance sheet earned this period:

$$ROA = \frac{\text{Net income}}{\text{Assets}}$$

On $45,000 of net income against $800,000 of assets, ROA is 5.625 percent. Equity on that sheet is $300{,}000$, so ROE is 15 percent. The equity multiplier is 2.67, and $5.625 \times 2.67 = 15$ once both are the two-decimal printings of $8/3$ and the 5.625 percent.

The ROA calculator on this page is that one division. DuPont analysis writes 5.625 percent as 9 percent net margin times 0.625 asset turnover. ROA against ROE is the pair.

Keep assets at $800,000. Raise net income to $60,000. ROA rises to 7.5 percent. The asset base did not shrink. The year earned more after interest.

Equity on the less-borrowed sheet is $600{,}000$, multiplier 1.33, ROE 10 percent. $7.5 \times 1.33 = 10$. A higher ROA and a lower ROE can live together, because the multiplier fell faster than the asset return rose.

Net income $80,000 on $500,000 of assets is a 16 percent ROA. Equity $400{,}000$, ROE 20 percent, multiplier 1.25. $16 \times 1.25 = 20$.

A higher ROA can be a more profitable year or a smaller asset base under the same profit. This page does not see sales. Turnover is the sales-over-assets piece on the DuPont page.

Net income is after interest. A heavier coupon lowers ROA even if EBIT did not move. ROIC takes the financing out by using NOPAT and invested capital. Lining ROA up against ROIC as if they priced the same capital is the usual mix-up.

Interest coverage is whether the coupon is covered. ROA is whether the residual, after that coupon, is large against the assets.

Total book assets, not current assets, and not market cap. Current assets are the current ratio question. Market cap is the market capitalisation question. Mixing either in as the denominator is a different ratio.

It is not ROE, not ROIC, and not a target of 5.625 percent. The three sheets are 5.625 percent on $45,000 over $800,000, 7.5 percent on $60,000 over $800,000, and 16 percent on $80,000 over $500,000. This is educational material, not financial advice.