Difference Between ROE and ROA

Two crucial parameters for analyzing a business are the Interpet ROE and return on assets Interpet ROEInterpet ROEReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more and return on assets (ROAROAReturn on assets (ROA) is the ratio between net income, representing the amount of financial and operational income a company has, and total average assets. The arithmetic average of total assets a company holds analyses how much returns a company is producing on the total investment made.read more).

Return on equity and Return on assets are known as profitability ratios, as they indicate the level of profit generated by a business.

What is ROE?

Return on equity measures how much a business earns concerning the amount of equity put in the business. Return on equity is a ratio calculated with net income as the numerator and total equity as the denominator.

  • Net income is an income statement item, and total equity comes from the balance sheet; that’s why the average of equity is considered for calculating the ratio.A higher ratio signifies that the business is doing well as it can generate a high amount of profit, given a particular level of investments in the form of equity.Return on equity is also popularly calculated using the DuPont formulaDuPont FormulaDuPont formula determines the return on equity (ROE), depicting the efficient utilization of shareholders’ capital into the business for generating revenue. The formula is “Return on Equity (ROE) = Profit Margin * Total Asset Turnover * Leverage Factor”.read more. DuPont analysis is the combination of three ratios, which helps identify which parameter results in the increase or decrease of ROE.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: ROE vs ROA (wallstreetmojo.com)

What is ROA?

Return on assets is a measure to gauge how much profit the business generates with the number of total assets invested in the business. This ratio is measured with net income as a numerator and total assets as a denominator.

  • In another way, this measures how much profit the business generates with the funds invested by the equity shareholder’s preferred shareholders and total debt investment.Total assets are funded by both equity and debt holders. All these sets of investors provide the funds required for the total assets. It is necessary to add back interest expenses in the net income, which seats in the ratio’s numerator.In the case of ROA, as in the case of ROE, the numerator is an income statement item, and the denominator is the balance sheet item. That’s why the average of the total asset is taken in the denominator.

ROE vs. ROA Infographics

Critical Differences Between ROA vs. ROE

The followings are the key differences:

  • With the help of ROE, we can measure how much a business is earning concerning the amount of equity put in the business. In contrast, ROA tells us how much profit is being generated by the business with the total amount of assets invested in the business.While calculating ROE, the net income is the numerator, whereas the total equity is the denominator. In a calculation of ROA, net income is the numerator, and the total assets are the denominator.Another way of calculating ROE is DuPont Analysis, but no such measures are available to calculate ROA.For the calculation of ROE, we only consider equity investors, but for the calculation of ROA, equity shareholders preferred shareholdersPreferred ShareholdersA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more, and total debt investment, all are taken into account.While calculating ROE, no adjustment in the numerator is required since only equity is considered the denominator. For calculating ROA, it is essential to add back interest expenses to the numerator since the total asset is funded by both equity and debt holders.

Comparative Table

Conclusion

Return on equity and return on assets are known as profitability ratiosProfitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more, as they indicate the level of profit generated by a business. While deciding and concluding about a company’s financial health and performance, it is essential to consider both ROA and ROE since both these ratios are very important.

Combining the results helps us get a fair idea about the effectiveness of the company management of any company.

This article has been a guide to ROE vs. ROA. Here we also discuss the top differences between ROE and ROA and infographics and a comparison table. You may also have a look at the following articles –

  • Shares vs. DebenturesCalculate EBITDAReturn on Average EquityReturn on Equity Formula