Chartered Financial Analyst (CFA) Level 1 Practice Exam

How is Return on Assets (ROA) calculated?

1. Net income / average total assets

2. Operating income / average total assets

3. Gross profit / total assets

4. Net income / total assets

The correct answer is: Net income / average total assets

Return on Assets (ROA) is a key financial metric used to assess how effectively a company uses its assets to generate profit. The correct method for calculating ROA is by taking net income and dividing it by the average total assets over a specified period. This calculation shows the proportion of earnings generated from the company's asset base, which is crucial for investors and analysts in evaluating operational efficiency. Choosing net income as the numerator captures the returns attributed to the shareholders after all expenses, including taxes and interest, have been deducted. By using average total assets, the calculation accounts for asset fluctuations over the reporting period, providing a more accurate reflection of asset utilization. This emphasis on net income provides a clearer picture of actual profitability relative to the total assets employed in generating that income. Calculations using operating income, gross profit, or total assets as described in the other options do not accurately encapsulate the relationship between profitability and asset utilization in the same way, as they fail to consider the impact of expenses or do not adjust for the average asset base throughout the period.