Multiple Choice
Which one of the following is the correct equation for computing Return on Assets (ROA)?
131
views
14. Financial Statement Analysis
Ratios: Return on Assets (ROA)
Multiple Choice
Which one of the following formulas correctly computes the Return on Assets (ROA)?
A
ROA = \(\frac{Gross\ Profit}{Net\ Sales}\)
B
ROA = \(\frac{Net\ Income}{Average\ Total\ Assets}\)
C
ROA = \(\frac{Total\ Assets}{Net\ Sales}\)
D
ROA = \(\frac{Net\ Income}{Total\ Equity}\)
Verified step by step guidance1
Step 1: Understand the concept of Return on Assets (ROA). ROA is a financial ratio that measures how efficiently a company uses its assets to generate profit. It is calculated by dividing Net Income by Average Total Assets.
Step 2: Analyze the given formulas. The correct formula for ROA is ROA = \( \frac{Net\ Income}{Average\ Total\ Assets} \). This formula directly relates the company's profitability (Net Income) to the resources it has employed (Average Total Assets).
Step 3: Eliminate incorrect options. For example, ROA = \( \frac{Gross\ Profit}{Net\ Sales} \) is not correct because it measures gross profit margin, not asset efficiency. Similarly, ROA = \( \frac{Total\ Assets}{Net\ Sales} \) and ROA = \( \frac{Net\ Income}{Total\ Equity} \) are formulas for other financial metrics, not ROA.
Step 4: Confirm the correct formula. The correct formula for ROA is \( \frac{Net\ Income}{Average\ Total\ Assets} \), as it aligns with the definition of ROA and measures the efficiency of asset utilization.
Step 5: Apply the formula in practice. To calculate ROA, gather the Net Income from the income statement and Average Total Assets from the balance sheet (calculated as the average of beginning and ending total assets for the period). Then, divide Net Income by Average Total Assets to compute ROA.
Related Videos
Related Practice
