What Is the Cash Return on Assets Ratio?
The cash return on assets (cash ROA) ratio is used to benchmark a business's performance with other businesses in the same industry. It is an efficiency ratio that rates actual cash flows to company assets without being affected by income recognition or income measurements. The ratio can be used internally by the company's analysts or by potential and current investors.
Key Takeaways:
- The cash return on assets (cash ROA) ratio is used to benchmark a business's performance with other businesses in the same industry.
- Cash ROA rates actual cash flows to assets without being affected by income.
- The ratio is useful to company analysts or potential and current investors.
- A high cash ROA ratio typically indicates that a company earns more net income from $1 of assets than the average company, which is a sign of efficiency.
- A low cash ROA ratio typically indicates that a company makes less net income per $1 of assets, which is a sign of inefficiency.
Understanding the Cash Return on Assets Ratio
Fundamental analysts believe a stock can be undervalued or overvalued. That is, fundamental analysts believe in-depth analysis can help increase portfolio returns. Fundamental analysts uses a variety of tools, including ratios, to assess portfolio returns. Ratios help analysts compare and contrast data points, such as return on assets (ROA) and cash ROA. When these two ratios diverge, it is a sign that cash flow and net income are not aligned, which is a point of concern.
ROA vs. Cash ROA
Return on assets is calculated by dividing cash flow from operations by average total assets.
CashReturnonAssets=TotalAverageAssetsCashFlowfromOperations
The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings.
A high cash ROA ratio means the company earns more net income from $1 of assets than the average company, which is a sign of efficiency. A low cash ROA ratio means a company makes less net income per $1 of assets, which is a sign of inefficiency.
The issue is that net income is not always aligned with cash flow. As a solution, analysts use cash ROA, which divides cash flows from operations (CFO) by total assets. Cash flow from operations is specifically designed to reconcile the difference between net income and cash flow. In this way, it is a more accurate number to use in the calculation of ROA than net income.
Example of Cash Flow and Net Income Misalignment
As an example, if Company A has a net income of $10 million and total assets of $50 million, ROA is 20%. Company A also has high sales growth due to a new financing program that gives all customers 100% financing. As a result, net income is high, but the increase in net income is the result of an increase in credit sales. These credit sales increased sales and net income, but the company has received no cash for sales.
Cash flows from operations, a line item that can be found on the cash flow statement shows the company has $5 million in credit sales. Cash flows from operations deducts this $5 million in credit sales from net income. As a result, cash ROA is calculated by dividing $5 million by $50 million, which is 10%. In actuality, assets generated a lower amount of "real" cash earnings than originally thought.
FAQs
Cash ROA. Return on assets is calculated by dividing cash flow from operations by average total assets. The answer tells financial analysts how well a company is managing assets. In other words, ROA tells analysts how much each dollar of assets is generating in earnings.
How do you interpret return on assets ratio? ›
The ROA figure gives investors an idea of how effective the company is in converting the money it invests into net income. The higher the ROA number, the better because the company is able to earn more money with a smaller investment. Put simply, a higher ROA means more asset efficiency.
What does a return on assets of 12.5% represent? ›
What does a return on assets of 12.5% represent? A return on assets (ROA) of 12.5% means that for every $100 of total assets on the company's balance sheet, it generates $12.50 in net income.
What is a good cash flow to asset ratio? ›
Cash Flow to Assets Analysis:
It relates a company's ability to generate cash compared to its asset size. A ratio of 0.30 (30%) is quite good, Cory's Tequila Co. shouldn't run into any problems generating cash.
What is a good cash to total assets ratio? ›
An ideal cash asset ratio would be 1. It indicates a company is able to pay off its short-term obligations with its most liquid assets but also does not have too much cash sitting around that is not being put to use.
What is a bad return on assets ratio? ›
What is considered a good and bad return on assets? A good return on assets is in the 10% range. Anything above that is excellent and below 5% is considered harmful. A company with a ROA of 15% or higher is doing very well, while one with 1% or lower is likely in trouble.
What is an example of a return on assets ratio? ›
Method 1 example
150,000 / 800,000 = 0.1875. Then convert the resulting quotient to represent the company's return on assets as a percentage (0.1875 x 100 = 18.75%). The company's return on assets is 18.75%.
What is the average return on assets ratio? ›
Understanding Return on Average Assets (ROAA)
A ratio result of 5% or better is generally considered good. Net income is found on the income statement, which provides an overview of a company's performance during a given time period. Analysts can look to the balance sheet to find assets.
What does an asset turnover of .5 mean? ›
The formula was first used in the 1920s as part of the Dupont company's analysis and has become an industry standard since then. For example, an asset turnover ratio of 0.50 indicates that the company in question is able to convert every dollar of assets into 50 cents worth of revenue.
What is a good ROA and ROE? ›
Experts usually say that a ROA of 5% or 10% is usually good, while 20% or higher means excellent. Generally speaking, the higher the ROA, the more efficient the company generates income. However, this number can be different depending on the sector of your company.
Lower returns: Since cash is largely a risk-free asset, investors don't get the “risk premium” that other investments, like mutual funds or GICs, may come with. Inflation risk: While cash has no capital risk, inflation can erode its purchasing power – meaning you wouldn't be able to buy as much with it in the future.
What are examples of cash assets? ›
Cash assets
- savings.
- shares.
- stocks.
- bonds.
- loans to others.
A loan may be considered both an asset and a liability (debt). When you initially take out a loan and it is received by you in cash, it becomes an asset, but it simultaneously becomes a debt on your balance sheet because you have to pay it back.
Is a higher return on total assets ratio better? ›
ROA Formula / Return on Assets Calculation
This ratio indicates how well a company is performing by comparing the profit (net income) it's generating to the capital it's invested in assets. The higher the return, the more productive and efficient management is in utilizing economic resources.
Should ROE be high or low? ›
The higher the ROE, the better a company is at converting its equity financing into profits. To calculate ROE, divide net income by the value of shareholders' equity.
