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Net Income/Beginning of Year Total Assets
We’ve got to get this figure from the balance sheet. But there isn’t much that’s interesting going on with SnowPlow’s balance sheet (for this discussion) so let’s make some numbers up. The assets of the company are simply the things it owns—land, leases, brand name’s it has purchased, etc. This ratio begs the question: How well are our assets being used? Let’s say the assets of SnowPlow are $50,000,000. Then the ROA is 16%. We have to ask what if these assets were used by someone else—could that other person use our assets better? Say SnowPlow’s assets consist mostly of the land its factory is on, the machinery to press the skis and a brand name “Rossignol” to whom it paid a lump sum up front plus royalties on sales (Rossignol doesn’t really do this but you get the basic idea).
What if we found that mini-mall developers were getting 50% return on land adjacent to where our factory was sitting? What if we found other applications for our ski-pressing machinery—high tech ironing boards?—and that return competitors in the high-tech ironing biz were getting 50% return. What if we found that the low-bran ski maker also leased Rossignol’s name and was getting much better returns than ours? Maybe at this point we have to reevaluate our company. What if we just picked up our team and moved our factory elsewhere? Maybe it’s not such a good company after all (relative to our competitors) and the next market downturn we’ll be out of business.
If we flip the number completely around so that it looks like we’re getting great ROA then maybe we can leverage ourselves a bit more based on our returns—maybe we can buy some other poor schlep’s lousy-running factory and land for a relatively cheap price (if he’s getting low ROA then we should be able to buy it for a low price). We can then turn those assets into better returns and we’re golden—this is sort of what Henry Ford did when he automated the car-making world.