How to Increase Return on Asset (ROA)
Return on Asset (ROA) is one of the tools used to evaluate company profit compare to the total asset. It shows how efficiently the company uses the asset to generate profit. The investors pay close attention to this ratio as it will tell how effective their investment when they decide to invest in any company. It is one of the best tools which investors use to compare similar company before deciding to make an investment. Shareholders are looking to maximize their wealth after investing. ROA is popular because it takes into account both liabilities and equity.
High ROA means that the assets are well managed and generate high returns. On the other hand, the low ROA means that the company fails to generate profit from the available assets. Yes, the investors will be looking for a company with a high ROA.
Increasing return on asset is one of the goals which top managements are trying to achieve to satisfy the shareholder. It is one of the key performance indicators set by the board directors to the top management (CEO). So they are working very hard to achieve a certain ROA level to get the bonus.
Just a quick recap of return on the asset as following:
|Return on Asset = Net income / total Asset|
How to Increase Return on Assets
In order to increase ROA, we have to increase the net income or decrease the total asset, it is basic math. However, everything is interconnected in the accounting concept and any decision will have a subsequent impact on the business. Please check the following points:
Increase Net Income
Yes, it is one of the big goal for every company. They are working very hard to increase profit to increase shareholders’ wealth and expand the business. Beside of that, increasing it also improve the return on asset. There are many ways to increase the profit which include increasing sale, reduce the cost of goods sold and minimize the operating expense.
The company may set the target sale for the marketing department to attract customers and increase market share. They have to compete in the market to obtain the market share.
Besides that, we can reduce the cost of goods sold by improving the production process by eliminating the non-value added activities which do not provide any value to customers. We have to ensure that the deduction does not affect product quality.
Moreover, we can decrease the operating expenses which are not necessary to save and increase profit. But we have to make sure the expenses are used effective, not all expenses are needed to decrease.
Manage Current Asset
Current asset include Cash, Accounts receivable, Inventory, and other short term asset. If we can effectively manage them we will be able to improve the return on assets by keeping them as low as possible. As they are the asset, so by decreasing them, it will help to increase ROA.
We can reduce accounts receivable by collecting the money as fast as possible from the customers. We will be able to use cash for other investments to generate more profit. But we have to check if it impacts our sale volume as the customers may looking for a longer credit period as they make a bulk purchase which requires a longer time to sell and get cash for us.
Effective inventory will allow us to store minimum level of stock but still meet customers’ demands.
Manage Fixed Asset
Fixed Asset has both impacts on net income and total asset. If the company has a huge fixed asset, it will increase the total asset. At the same time, it also reduces the net profit due to high depreciation expenses. So it has a negative impact on both net income and total assets, as the result, the ROA will be significantly decreased.
In order to reduce to solve this issue, we have deeply analyzed each property performance to find the low performance to get rid of them.
Another possible solution is to increase production capacity to maximize the fixed asset utilization. So that we will be able to generate more sales from that asset without further investments.
Manage other Investment
The company may have investments in other companies in form of associates, financial assets, or other types of investments. These investments will generate return different from the business operating activities. So we have to check and compare to the company return. If they are generating a lower profit compared to the current business, it means we can increase ROA by getting rid of that investment. We can sell them and expand our business to get more return, or we may decide to invest in other companies with higher returns. However, we cannot decide to sell just base on this information, we have to look at many others factors.
These investments can be the cause of lower company overall ROA but they can be the cause of increasing ROA too. If their performance is much better than the company, they will help to increase the company’s total ROA.
Decrease Total Asset
The company could decrease the total asset to increase ROA while the net profit remains the same. We should look into both a current asset and non-current asset and identify the low performance asset and performance analyzing. We can compare between own and leasing those assets. For some seasonal assets, leasing is a good choice. We can arrange the leasing schedule only in the peak seasons, so we will be able to save in low season. Moreover, we can get the latest machine while we do not to worry about repair and maintain expense.
Good Return on Asset
Every company is looking to increase the ROA, but what is the target. What is a good return on assets? This is quite hard to answer as the business is different from one to another. We cannot give an answer that fits all business. Businesses such as retail, food, and beverage would have a higher ROA if compare to other business such as airlines, car manufacturers, and telecommunication.
The target ROA usually decide by the company board of directors who use many benchmark such as industry average, cost of capital, and economic growth. So it is considered as the target ROA for the company. It may be different from one company to another.
Maximizing ROA is one of the top management target to satisfy the shareholder and receive bonus. However, some managements may scarify the company long term benefit in exchange for a short increase in ROA. For example, they reduce the amount of new investment which will generate more profit in the long term as it impacts the current ROA. So ROA should be adjusted for such cases to prevent this kind of problem.