As a business leader, you are barraged with endless acronyms for measuring the financial performance of your business, including NAV (net assets value), EPS (earnings per share), KPI (key performance indicator), ROI (return on investment), just to name a few. It can be overwhelming to know which acronyms are meaningful metrics for your business.
The Numbers Coach recommends starting with two simple acronyms: ROA (return on assets) and ROE (return on equity). These metrics are simple yet effective indicators of the overall financial health of a business.
Return on Assets
ROA is a financial ratio that measures the profitability of a business in relation to its total assets. It is calculated by taking your company’s annual net income and dividing by its total assets including facilities, machinery, equipment, vehicles, inventory, etc. To put it simply, ROA shows how effective your company is at using assets to generate profit.
Here’s an example: if your company’s net profit is $248 and the total assets in your business are $5193, divide 248 by 5,193 and you have a 4.8% return on assets.
What is a good ROA? It’s usually the highest, but it depends on the industry. It is important to judge your business’s ROA against the competition. What is a great ROA in one industry may not be in another. Banks, for instance, bring in as much deposited money as possible and use it to offer loans at a higher return. They are known to have low ROAs versus a software company having a higher ROA. An ROA that is much higher than the industry norm may suggest the company isn’t renewing its assets for the future.
Return on Equity
ROE, or return on equity, is a similar calculation used to measure financial performance. To calculate ROE, net income is divided by average shareholders’ equity. ROE uses equity, the net worth of a company, not just what it owns. It tells businesses what percentage of profit they make for every dollar of equity invested in their company. In other words, ROEs show the return on a corporation’s profitability and how efficient it is at generating profits for the owners. Here, as with gross margins and net margins, the higher the numbers, the better.
ROAs and ROEs are important tools used to indicate the financial success of a company over a specific time. If these financials are in order, they can be a relatively simple way to quickly demonstrate your company’s performance.
Need some guidance for calculating and applying these metrics in your business? Contact the Numbers Coach for a free consultation.