What is ROA, ROE? Meaning, calculation and application

ROA is the ratio of a company's profitability to its financials. Through ROA will let users know the efficiency of the Company when using assets to make a profit. This is as important an indicator as ROE in choosing good stocks. So the question arises whether? ROA formula How is it calculated? What does ROA mean?

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ROA, ROE . worksheet

Below is a detailed ROA and ROE spreadsheet.

What is ROA? What does ROA stand for?

ROA (short for English phrase - Return on Assets) is the rate of return on total assets. Calculating ROA will tell us how efficient the company is in using assets to make a profit.

ROA formula in calculation

ROA stands for Return of Assets. ROA helps many investors honestly evaluate the process of using assets from the business when intending to invest. And basically to calculate the ROA is not too complicated. All you just need to apply via ROA formula is to be.

Formula for calculating ROA

ROA = Profit after tax (Earnings) / Assets (Assets) * 100%

In there:

Earning: This is understood as profit after tax. This is the net profit mainly used for common stock.

Assets: Also known as the average total assets. This is the total assets that the business has.

100%: ROA is calculated in units of %

Note that the total assets of the business do not have to be calculated lightly. Instead, there are specific formulas. And that formula is equal to public equity with debt.

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Illustrated example of how to calculate ROA

The formula for calculating ROA looks easy at first glance. However, you should still refer to specific examples. Thus, you will somewhat understand this problem when applying. Specifically:

JM Company has an expected net income of about 1 million USD. The total assets of the company at this time are about 5 million USD. This is an asset that has been remarried between equity and debt. So now we apply the formula 1:5 x 100% = 20%.

However, if the HK company also has the same income with total assets over 10 million USD, the ROA will be different. At this point, company B will have an expected ROA of about 10%. If we put the balance between the two companies JK and HK, JK is more effective in turning investment into profit.

A 3-year ROA of about 10 percent is considered a well-financed company

Reference: What is IRR?

Meaning of ROA

ROA Formula was born to calculate ROA index - a good indicator in the application of assets from businesses. The higher the ROA, the more efficient the asset utilization process. For example, in securities, if there is a large ROA ratio, it will be the preferred stock. And of course those securities will be priced higher than normal. Through the index, investors will get essential information about the profits generated from the initial capital.

So what ROA is considered the best?

Basically, compared to ROE, ROA is less important. But not unimportant. The relationship of ROA and ROE is mostly through the debt ratio. According to the standard, a company is financially viable when ROE > 15% and ROA > 7.5%. This is the milestone that the achieving units need to achieve for experts and investors to appreciate.

Please carefully consider ROA when investing

However, you may not consider a single year to calculate such an ROA. Instead, to give a global picture of capacity, the minimum period of time should be 3 years. If during that time the business maintains ROA >= 10%, then it is a standard business. Note that this is not the right milestone for finance-related fields. Including insurance, banking, securities…

Reference: What is a special economic zone?

What ROA is good for Business?

ROA is also an important metric besides ROE. The relationship of ROA and ROE is through the debt ratio. Debt is as little as possible, it is better if Debt/Equity < 1. International standard: ROE > 15%, is assessed as a financially viable company. Then ROA > 7.5%

However, this relationship should be considered for many years (3 years or more), if the business maintains ROA >=10% and lasts at least 3 years, then it is a good business. An increasing ROA trend proves that the business uses assets more efficiently.

There will be a conclusion about how good ROA is according to the formula below:

ROA > 7.5% + ROA increasing + Maintain at least 3 years => Good business.

What is ROE?

ROE (Return on Equity) is an indicator of return on equity. ROE represents the ratio between profit to equity that a business uses in its operations to evaluate the efficiency in using capital.

Formula for calculating ROE

ROE = (Earnings after tax/Equity) x 100%

Profit after tax is the amount of income, net expenses and taxes that a company generates over a given period of time.

Equity is the difference between a company's assets and liabilities. This is the amount left over if a company decides to pay off its debts at a certain time.

Meaning of ROE

ROE is expressed in %, showing how much profit a business spends on a pile of equity. The higher the ROE, the more efficient the company's capital is.

The calculation of ROE has many meanings such as:

Clearly outline the percentage of return earned by equity shareholders.

It helps investors compare the performance of different stock investments. That affects their future investment strategy.

How much ROE is good?

The industry average ROE of the operating company determines how much ROE is good or bad, so ROE comparisons are often most meaningful between companies in the same industry.

Example: In 2020, the standard ROE for companies in the auto industry is around 12.5%. However, the ROE of a company in the retail sector is more than 18%. The higher the ROE, the more it shows that the company is managing and using its capital effectively.

Analysis of ROA and ROE in business

Normally, on stock exchanges, investors often pay attention to stocks of companies with ROA and ROE ratios that have a steady growth. And this is considered as the main indicator for investors to determine whether a company's stock has the ability to develop or not.

However, in analyzing ROA and ROE, it is still necessary to pay attention to the business lines of that company or enterprise. Because between two businesses operating in two different fields, there is often a huge difference between these two indexes. Even in a situation where ROE and ROA are equal or different, investors need to analyze more about many different aspects of the business before making an investment.

Therefore, based on the ROA index helps the analyst to see how the business ability of his business brings profit from shareholder's capital. In addition, it is necessary to analyze more loan ratios, bank interest rates, etc.

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The relationship between the two ratios ROA and ROE

We have the formula financial leverage as follows:

Financial leverage = Assets / Equity = ROE/ROA

Therefore, it can be seen that ROA and ROE have a close relationship with each other and directly affect the performance of the Enterprise.

To talk about the correlation between ROA and ROE, we rely on the Dupont analytical model.

ROE = ROA * Financial leverage = ROA * Total assets/equity = ROA * (1+Total debt/equity)

Note: Total Assets = Total Equity or (Total Debt + Equity)

In addition, the coefficients below can be further developed to see the calculated ROE based on the coefficients of net profit margin, asset utilization efficiency, financial leverage coefficient.

ROE = (EAT/Revenue) * (Revenue/Total Assets)*(Total Assets/Equity)

Thus, the change of ROE is determined by many factors such as profitability from revenue (ability to control costs, tax rates, interest rates...), ability to use assets (ability to generate income, etc.) income from the use of capital to finance assets in production and business) or the ratio of using debt.

Note: ROA and ROE in %. The variables in the calculation of ROA, ROE are taken from the balance sheet and income statement of the enterprise. Notably, stocks to be listed on HOSE and HNX must meet the ROE ratio of at least 5% in the latest year.

Example showing the relationship between ROA and ROE

There are two companies X and Y with the following business performance:

Company X: Equity: 200 billion VND, Debt 0 VND, Profit after tax: 40 billion VND

Company Y: Equity: 400 billion VND, Debt 150 VND, Profit after tax: 100 billion VND

Then, companies X and Y have ROEs of 20% and 25% respectively. Meanwhile, the ROA of company X and Y are: 20% and 18.1%, respectively.

We see that company X has no debt, and company Y has debt. ROE of the two companies is greater than 15%, indicating that the company's financial position is stable. However, the ROA of company X is greater than that of company Y. Therefore, company X is using capital more efficiently than company.

Conclusion

Overall, ROA is a simple but really popular metric among investors. You should combine ROA with other metrics to get an overview of how well your business is performing. Hopefully with the answers and analysis above, you will pocket for yourself the essential information. At the same time can be easily applied ROA formula. And don't forget to visit the website https://banktop.vn/ When you need an answer to something.