Difference Between ROE and ROA
ROE is a measure of financial performance which is calculated by dividing the net income to total equity while ROA is a type of return on investment ratio which indicates the profitability in comparison to the total assets and determines how well a company is performing; it is calculated by dividing the net profit with total assets.
Two crucial parameters for analyzing a business are the 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. 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.).
Return on equity and Return on assets these ratios 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 with respect to the amount of equity put in the business. Return on equity is a ratio that is 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 for calculating the ratio, the average of equity is considered.
- A higher ratio signifies that the business is doing well as they are able to 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".. DuPont analysis is the combination of three ratios, which helps in identifying which parameter is resulting in the increase or decrease of ROE.
What is ROA?
Return on assets is a measure to gauge how much profit is generated by the business 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 is generated by the business with the funds invested by the equity shareholder’s preferred shareholders and also total debt investment.
- All these sets of investors provide the funds required for the total assets. Total asset is funded by both equity and debt holders it is necessary to add back interest expenses in the net income, which seats in the numerator of the ratio.
- In the case of ROA also 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 with respect to the amount of equity that is 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 for calculation of ROA.
- For the calculation of ROE, we only consider equity investors, but for the calculation of ROA, equity shareholders, preferred shareholders, and total debt investment, all are taken into account.
- While calculating ROE, no adjustment in the numerator is required to be done since only equity is considered as the denominator. For the calculation of ROA, it is essential to add back interest expenses to the numerator since the total asset is funded by both equity and debt holders.
|Basis||Return on Equity(ROE)||Return on Assets(ROA)|
|Introduction||Return on equity measures how much a business earns with respect to the amount of equity put in the business.||Return on assets is a measure to gauge how much profit is generated by the business with the number of total assets invested in the business.|
|Difference in denominator||Return on equity is a ratio that is calculated with net income as the numerator and total equity as the denominator.||This ratio is measured with net income as a numerator and total assets as a denominator.|
|DU Pont Analysis||ROE is also calculated using du Pont analysis, which helps to identify whether ROE has increased due net profit marginNet Profit MarginNet profit margin is the percentage of net income a company derives from its net sales. It indicates the organization's overall profitability after incurring its interest and tax expenses. or leverage or is it due to an increase in asset turnover||No such measures applicable for the calculation of ROA|
|Investors||Only equity investorsEquity InvestorsAn equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc. are considered for the calculation of ROE.||ROA measures how much profit is generated by the business with the funds invested by the equity shareholders preferred shareholders, and also total debt investment as the funds required for the total assets is provided by all these set of investors.|
|Adjustment||For the calculation of ROE, it is not required to adjust the numerator of the ratio as the denominator is only equity, not the combination of both debt and equity. As debt is not involved, interest need not be added back in the numerator.||As the total asset is funded by both equity and debt holders, it is required to add back interest expenses in the net income, which seats in the numerator of the ratio.|
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., 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 very much essential to consider both ROA and ROE, since both these ratios are very much important.
Combining the results help 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 along with infographics and a comparison table. You may also have a look at the following articles –