Return on Assets and Return on Equity
Return on assets (ROA) and return on equity (ROE) are two key measures to determine how efficient a company is at generating profits.
ROA evaluates how effectively a company uses its assets to generate profit, whereas Return on Equity (ROE) shows much of a company’s profit is returned to shareholders by comparing net income to shareholders’ equity.
ROE focuses on the return generated on the shareholders’ equity while ROA focuses on the return generated on the total assets of the company, including debt. So, the primary differentiator between ROE and ROA is financial leverage or debt.
But if that company takes on financial leverage, its ROE would be higher than its ROA only if the company earns more on the borrowed funds than the cost of borrowing.
Both these two distinct financial ratios use net income as their starting point.
Return on Assets (ROA)
ROA is net income divided by total assets. This ratio measures how well a company is using its assets. ROAs can vary based on industry; hence When comparing ROAs across different companies, consider the scale of their businesses and the nature of their operations.
ROA = Net Income ÷ Total Assets
Example: Suppose ABC company has net income of Rs.10, 00,000/- and average total asset is Rs.40, 00,000/- then ROA will be-
ROA = Net Income ÷ Total Assets= 10, 00,000 / 40, 00,000 = 25%
Return on Equity (ROE)
ROE is net income divided by shareholder equity. ROE measures profitability by relating how well a company generates profit from money invested by shareholders. In other words, it measures how effectively a company utilizes shareholders’ capital to generate profits.
ROE = Net Income ÷ Shareholders’ Equity
Example: Suppose ABC company has net income of Rs.10, 00,000/- and average Shareholders’ Equity is Rs.20, 00,000/- then ROE will be-
ROE = Net Income ÷ Shareholders’ Equity = 10, 00,000 / 20, 00,000 = 50%
See also…
Bonds & Debentures: Meaning, Types & Differences
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