Return on assets (ROA) is defined as .

ROA is one of the most common performance measures. It mixes the income statement’s results with the balance sheet’s results, answering the question, “How good are we at producing wealth with our assets?”

As a measure, ROA has two drawbacks:

• It pays little attention to sales growth.
• It biases behavior towards the accumulation of equity.

When ROA is used alone, management pushes for increased profits while minimizing assets.

Because interest payments reduce profits, management avoids debt where possible.

Management is torn about increasing the size of the asset base. On the one hand, with assets in the denominator, any increase in assets makes it difficult to improve ROA. On the other, overall profits depend in part on sales volume. If we increase sales volume while holding ROS constant, the absolute profits must increase.

Management becomes cautious. When buying an asset, they must be confident that enough profit will flow from the investment to maintain or improve ROA. When funding the investment, they avoid debt, thereby limiting the size of the investment and increasing pressure to do stock issues.

In the end, assets grow slowly. Debt falls. Profits are retained. Stock is issued, but because there are no dividends, stock price stays flat.

Assets Minimally Increased To Emphasise ROA