ACCOUNTING AND FINANCE FOR DECISION MAKING

(GSFM 7514)

REFLECTIVE TASK 01

IS ROA A BETTER PERFORMANCE MEASUREMENT THAN ROE? DISCUSS.

PREPARED BY
LAVANNYA MOORTHY
(MC191010006 - ONLINE)

SUBMITTED TO
EN ROSLAN BIN HJ MOHD ROSE
(FACULTY OF BUSINESS AND TECHNOLOGY)

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Contents
1.0 WHAT IS ROA..................................................................................................................3
1.0.1 ROA FORMULA.........................................................................................................3
1.0.2 WHY COMPANIES USES ROA?.............................................................................3
2.0 WHAT IS ROE...................................................................................................................4
2.0.1 ROE FORMULA.........................................................................................................4
2.0.2 WHY COMPANIES USES ROE...............................................................................4
3.0 ROE VS ROA.....................................................................................................................5
4.0 IS ROA A BETTER PERFORMANCE MEASUREMENT THAN ROE? DISCUSS.
....................................................................................................................................................6
5.0 REFERENCES...................................................................................................................6

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1.0 WHAT IS ROA
Return on Assets (ROA) is a type of return on investment (ROI) that will measure the
profitability of a business in relation to its total assets. This ratio will indicate how well a
company will be performing by comparing the net income that are generated to the capital .
The higher the return, the more productive and efficient the management will be in utilizing
the economic resources. 

ROA gives the investors an idea on the effects of the company has and how efficiently the
company is converting its investment into net income. Higher ROA shows the effectiveness
of the company in earning the money on lesser investment.

1.0.1 ROA FORMULA

 ROA = Net Income /Average Assets or

 ROA = Net Income / End of Period Assets or

 ROA = (Net Income + Interest Expense) / Average Total Assets.

**Net Income is equal to net earnings or net income in the year.

**Average Assets is equal to ending assets deduct the beginning assets and divided by 2.

1.0.2 WHY COMPANIES USES ROA?

 To determine profitability and efficiency.

Return on assets indicates the amount of money earned per currency of assets.
Therefore, a higher return on assets value will indicate that the business is more
profitable and efficient.
 To compare performance between companies

Companies in different industries vary significantly in their use of assets. For

example, some industries may require expensive property, plant & equipment

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 (PPE) to generate income as opposed to companies in other industries. Therefore,
these companies eventually will report on lower return on assets when compared to
companies that do not require a lot of assets to operate.

 To determine asset-intensive companies

Return on assets can be used as an instrument on how asset-intensive a company is:

i) The lower the return on assets, the more asset-intensive a company is. An example
of an asset-intensive company would be an airline company.

ii) The higher the return on assets, the less asset-intensive a company is. An example
of an asset-light company would be a software company.

2.0 WHAT IS ROE

Return on Equity (ROE) is the measure of a company’s net income divided by the value of its
total shareholders’ equity, expressed as a percentage. ROE can be derived by dividing the
firm’s dividend growth rate with earnings retention rate.

Return on Equity is a two-part ratio in its derivation because it brings together the income
statement and the balance sheet, where net income or profit is compared to the shareholders’
equity. The number represents the total return on equity capital and shows the firm’s ability
to turn equity investments into profits. To put it another way, it measures the profits made for
each dollar from shareholders’ equity.

2.0.1 ROE FORMULA

 ROE = Net Income / Shareholder’s Equity

2.0.2 WHY COMPANIES USES ROE

 Estimating the growth rate
The return on equity ratio is considered to be an effective way of measuring the
growth rate of a company’s stock and dividend. A company’s ROE is multiplied
with its retention ratio to calculate such growth. The retention ratio is the

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 proportion of the company’s net income that has been retained to enhance its
growth prospect.
 Gauging sustainability of growth
Return on equity ratio analysis will help to measure the company’s sustainability in
terms of its growth. With the help of this financial ratio, investors can identify
the stocks that are more exposed to market risks and financial in-stabilities .
For instance, a company stock that is growing at a relatively slow rate when pitted
against its sustainable rate could be seen as undervalued or financially struggling in
the market. Similarly, a company that is surpassing its sustainable growth ability
also projects a problematic or erratic image in the market as well.

Investors can also use the ROE ratio to determine the dividend growth of a
particular company. This type of estimations can be accurate by multiplying the
company’s ROE with its pay-out ratio. A company which shows its dividend
growth that is above or below the sustainable growth rate may indicate operational
risks.

3.0 ROE VS ROA

RETURN ON EQUITY RETURN ON ASSETS
An amount of profit a company To measure how the company earns
receives from the shareholder’s from their resources and assets.
investments.
Debt financial leverage not included ROA is a debt that are included in
in ROE. Balance Sheet.
To determine efficiency of capital. Deals with the operating
management that will determine the
efficiency.
ROE are calculated by dividing ROA doesn’t require preferred
preferred dividends from the dividends.
numerators.
Higher ROE does not impart ROA is a better measurement to
impressive performance about the determine the financial performance
company. of a company.
Higher ROE along with the ROA Higher ROE can mislead by lower

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 and manageable debt will produce ROA and huge debt will be imposed
profits. to the company.

4.0 IS ROA A BETTER PERFORMANCE MEASUREMENT THAN ROE? DISCUSS.

From my point of view, ROA and ROE weighs their own advantages and disadvantages. The
companies shareholders need to evaluate respective ratios to determine which will be the best
performance indicator. Besides that, investors need to understand well about the companies
in- order to avoid investing in companies that have high debt risk. Therefore, ROE and ROE
ratios should be reviewed by the investors.

As for me, ROA and ROE can’t be compared. The usefulness of ROA and ROE depends
solely on the industries or the companies. Each industries would prefer and thinks which will
be suitable to use the relevant ratios to determine which will provide a better performance
measurement for the company

5.0 REFERENCES
o https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-return-on-
equity-roe/
o https://www.educba.com/roe-vs-roa/
o https://groww.in/p/return-on-equity-ratio/
o https://www.fool.com/knowledge-center/should-a-companys-return-on-assets-be-
greater-than.aspx

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