Current Ratio – Formula, Meaning, Assumptions and Interpretations
The current ratio is the most popularly used metric to gauge the short term solvency of a company. This article provides the details about this ratio. Formula Current Ratio = Current Assets / Current Liabilities Meaning Current ratio measures the current assets of the company in comparison to its current liabilities. This means that the…
What are Common Size Statements ?
Common size statements are not financial ratios. Rather they are a way of presenting financial statements that makes them more suitable for analysis. However, analysts always use them in conjunction with ratio analysis. In fact, financial analysts use common size statements as the starting point to help them dig deeper. Common size statements tell them…
Cash Ratio – Meaning, Formula and Assumptions
The cash ratio is limited in its usefulness to investors and financial analysts. It is the least popular of the liquidity ratios and is used only when the company under question is under absolute duress. Only in desperate circumstances do situations arise where the company is not able to meet its short term obligations by…
Another metric that is widely used by investors to gauge the profitability of a company is Return on Assets (ROA). More about this very important ratio has been stated in this article.
Return on Assets = Earnings / Asset Base
The Return on Assets (ROA) ratio shows the relationship between earnings and asset base of the company. The higher the ratio, the better it is. This is because a higher ratio would indicate that the company can produce relatively higher earnings in comparison to its asset base i.e. more capital efficiency.
The ROA ratio assumes that the assets have been valued fairly on the books. However, in real life, it is a known fact that companies keep over and/or under valuing their assets to reduce taxation. This may affect the ROA adversely and reduce its usability as a profitability metric.
The Return on Assets ratio assumes that the company is using all its assets to run the day to day operations. This assumption is likely to be proved incorrect. A lot of companies hold significant cash on their balance sheet. The most valuable company in the world Apple Inc is one such example. Also many other companies hold a lot of impaired and obsolete assets which they plan to sell in the near future. This brings down the Return On Assets (ROA) ratio.
Return on assets compares the earnings that a company has generated to its asset base. The asset base could be financed by equity or by debt but it will not make a difference. Return on Assets is therefore independent of leverage.
Return on Assets is very sensitive to the stage of growth that a company is currently experiencing. In the introduction and growth stage, companies invest a lot of money to create asset bases. They may not use the asset base immediately and the benefits may be realized years later. Hence, two companies in the same industry, but at different stages of growth, will have very different Return On Assets.
Article Written by
Himanshu Juneja, the founder of Management Study Guide (MSG), is a commerce graduate from Delhi University and an MBA holder from the esteemed Institute of Management Technology (IMT). He has always been someone deeply rooted in academic excellence and driven by a relentless desire to create value. Recently, he was honored with the “Most Aspiring Entrepreneur and Management Coach of 2025 (Blindwink Awards 2025)” award, a testament to his hard work, vision, and the value MSG continues to deliver to the global community.
Article Written by
Himanshu Juneja, the founder of Management Study Guide (MSG), is a commerce graduate from Delhi University and an MBA holder from the esteemed Institute of Management Technology (IMT). He has always been someone deeply rooted in academic excellence and driven by a relentless desire to create value. Recently, he was honored with the “Most Aspiring Entrepreneur and Management Coach of 2025 (Blindwink Awards 2025)” award, a testament to his hard work, vision, and the value MSG continues to deliver to the global community.
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