LO7–7 Describe the links among return on assets, profit margin, and asset turnover.

What is the formula for Return on Assets (ROA)?

ROA = net income / average total assets

What does ROA measure?

How much net income a company generates for each dollar of assets.

Why do we use average total assets in ROA?

To match the time period of net income (a yearly measure) with assets (a point‑in‑time measure).

How do you calculate average total assets?

Beginning assets + ending assets / 2

Common mistake when calculating ROA

Using ending total assets instead of average total assets.

Interpretation of ROA

Higher ROA = more effective use of assets to generate profit.

Disney’s ROA = 1.5%. What does that mean?

isney generates 1.5 cents of profit for every $1 of assets.

Comcast’s ROA = 2.0%. What does that mean?

Comcast generates 2.0 cents of profit for every $1 of assets.

Which company is more profitable based on ROA?

Comcast, because 2.0% > 1.5%.

What two components make up ROA?

Profit margin × Asset turnover.

Formula showing ROA breakdown

Profit margin x Asset Turnover

Formula for profit margin

Net income / net sales

What does profit margin measure?

How much profit a company makes per dollar of sales.

How do companies increase profit margin?

Product differentiation, premium pricing, higher margins.

Formula for asset turnover

Net sales / average total assets

What does asset turnover measure?

How efficiently a company uses assets to generate sales.

How do companies increase asset turnover?

Lower prices, higher volume, more efficient asset use.

Why is Comcast’s ROA higher than Disney’s?

ecause Comcast has both higher profit margin and higher asset turnover.

How can managers manipulate ROA?

By overestimating service life or residual value, reducing depreciation expense and inflating net income.

Which ratios are affected by inflated net income?

ROA, profit margin, and any ratio using net income.

What two strategies increase ROA?

• Increase profit margin

• Increase asset turnover

High profit margin
Low profit margin

High —> company charges higher prices, has lower costs, more profit per sale

Low —> company charges lower prices, has higher costs, less profit per sale

High turnover
Low turnover

High —> company uses assets efficiently (more sales with fewer assets)

Low —> Company needs more assets to generate sales