What Is Return on Total Assets?
Return on total assets (ROTA) is a ratio that measures a company's earnings before interest and taxes (EBIT) relative to its total net assets. You can define it as the ratio between net income and total average assets, or the amount of financial and operational income a company receives in a financial year compared to the average of that company's total assets.
This ratio serves as an indicator of how effectively a company is using its assets to generate earnings. I use EBIT instead of net profit to keep the focus on operating earnings, avoiding the influence of tax or financing differences when comparing similar companies.
Key Takeaways
The return on total assets shows how effectively a company uses its assets to generate earnings. You can use the ROTA metric to determine which companies are reporting the most efficient use of their assets compared with their earnings. Be aware that some concern exists about ROTA relying on the book value of total assets rather than their market value, which can make the return look higher than it really is.
Understanding Return on Total Assets
The greater a company's earnings in proportion to its assets—and the greater the coefficient from this calculation—the more effectively that company is using its assets. Expressed as a percentage or decimal, ROTA gives you insight into how much money is generated from each dollar invested into the organization.
This allows you to see the relationship between resources and income, providing a point of comparison to determine if an organization is using its assets more or less effectively than before. In cases where the company earns a new dollar for each dollar invested, the ROTA is one, or 100 percent.
The Formula for Return on Total Assets – ROTA
The formula is Return on Total Assets = EBIT / Average Total Assets, where EBIT stands for earnings before interest and taxes.
To calculate ROTA, divide net income by the average total assets in a given year, or for the trailing twelve-month period if the data is available. You can also represent the same ratio as the product of profit margin and total asset turnover.
How to Calculate ROTA
To calculate ROTA, get the net income figure from a company's income statement, then add back interest and/or taxes paid during the year. This gives you the company's EBIT.
Divide the EBIT number by the company's total net assets to show the earnings generated for each dollar of assets on its books. Remember, total assets include contra accounts for this ratio, so subtract allowance for doubtful accounts and accumulated depreciation from the total asset balance before calculating.
Limitations of Using Return on Total Assets (ROTA)
Over time, an asset's value may diminish or increase. For real estate, the value might rise, but most mechanical assets like vehicles or machinery depreciate due to wear and tear.
Since the ROTA formula uses book values from the balance sheet, it may significantly understate the fixed assets' actual market value. This leads to a higher ratio result, showing a return on total assets that is higher than it should be because the denominator—total assets—is too low.
Another limitation is how the ratio handles financed assets. If debt was used to buy an asset, ROTA might look favorable, but the company could be struggling with interest expense payments.
You can adjust the ratio inputs to reflect assets' functional values while accounting for the interest rate paid to a financial institution. For instance, if an asset was acquired with a 5% interest loan and returned 20%, the adjusted ROTA would be 15%.
Since many newer companies have higher debt associated with assets, these adjustments might make the business look less attractive to investors. Once those debts clear, the ROTA will appear to improve.
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