From the formula itself, we can say ROA is about profitability relative to assets while fixed asset turnover is the ability to create revenues from the company’s fixed assets. And in both formulas, the smaller the denominator the more profitable and more effecient the company is. But sometimes the company only seems to be efficient when it is actually because the fixed assets have depreciated a lot. So I thought of adding back the accumulated depreciation to the fixed assets.
So do you guys think this is necessary? Do you guys have a much more efficient idea of making sure that we have a profitable and efficient use of assets not because of greatly depreciated fixed assets?
While I think your approach may have merit, it is not relevant to Level I. You’ve identified a benefit to being an analyst: you get to analyze whether or not a company is generating revenue from assets because of efficiency, or because assets have fallen out of favor. No single ratio should be used to determine the viability of the company.
How about waiting for Level 2 when you cover FRA in more detail, they actually cover those in more detail. On the side note:
ROA should use the average asset of the company, (begining + end)/2, or in more detail (Q1+Q2+Q3+Q4)/4. If the company is investing in maintaining its asset for its current operation, if should replace or reinvest into it as it goes. Therefore the depereciation should not distort the ratio substantial if the management does not do it intentionally, which sometimes happend and should be adjusted in that case.
The Return is the accounting net profit, which is after depreciation. If the depreciation is large then both return and the asset is affected by the same amount. Since every company in every given year are affected the same way by their depreciation, the comparability is possible.
So I don’t think your adjustment is needed in general, but can be useful in some cases. But remember, if you add depreciation back to the asset, you should also add back to the return.
