ROE vs ROA  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.

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 analysis is the combination of three ratios, which helps in identifying which parameter is resulting in the increase or decrease of ROE.

For eg:
Source: ROE vs ROA (wallstreetmojo.com)

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

For eg:
Source: ROE vs ROA (wallstreetmojo.com)

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.

Conclusion

Return on equity and return on assets are known as , 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.

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