# What is ROE, ROA? Meaning, calculation of ROA, ROE and application

ROA is known as an indicator of the correlation of profitability with the company's financials. Through the ROA index, users will know the efficiency when using assets to make a profit. So What is ROA?? How is the formula calculated? What does this indicator mean?

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## What is ROA?

ROA is an acronym for Return on Assets, it is an indicator of the rate of return on assets. This index is the ratio of profit to assets put into production and business, assessing the efficiency of using enterprise assets.

### ROA Formula and Example

#### How to calculate ROA

ROA will be calculated according to the following formula:

ROA = Profit after tax/Total assets x 100%

In there:

• Profit after tax = Total revenue – Total expenditure – CIT. Profit after tax is taken from the income statement of the enterprise.
• Total assets is the total value of assets of the enterprise at the reporting time, including: cash and cash equivalents, financial investments, receivables, inventory, fixed assets, real estate investment assets, construction in progress and other assets. Total assets are shown in the balance sheet.
• The unit of ROA is %.

#### Illustrated example of how to calculate ROA

An example for you to have a clearer picture of ROA is:

Company A has an expected net income of \$1 million, and its total assets are now \$5 million. This asset has been declared between equity and debt. So now the formula to calculate ROA is: 1:5 x 100% = 20%.

However, if company B also has the same income with total assets of more than 10 million USD, ROA is also different. Company B will then have an expected ROA of 10%. If we put the comparison table of companies A and B, it will be more effective to turn investment into profit.

### Meaning of ROA

The meaning of ROA is how much profit a business invests in assets with 1 dollar of capital. The higher the ROA, the higher the efficiency in using assets of the business.

Based on the ROA index, business managers will know how much capital to invest and how much net profit they bring. The higher the ROA, the more efficiently the business uses its assets.

ROA is also the basis for businesses to make business decisions. When comparing ROA between periods or with companies of the same size in the same industry. If the ROA is high, the business will continue to maintain the current business strategy, and if the ROA is low, business leaders need to adjust the business strategy.

#### For investors

ROA is also used by investors to select investment stocks. When comparing the ROA of businesses in the same industry, the higher the ROA, the better the profitability.

However, that also means a higher share price. Besides, you should also compare the ROA of the business with its past self to see if the business is doing better or not.

#### For the bank

ROA is the overall picture of the financial position of the business. The bank will rely on this index to assess the business situation of the business and make a decision whether to lend money to the business or not.

### How Much ROA Is Good For Businesses

ROA is an important metric like ROE, the relationship of ROA and ROE is through the debt ratio. The less debt the better, the better when debt/equity < 1. According to the international standard ROE > 15% is a company with sufficient financial capacity. Then ROA > 7.5%.

Even so, it is necessary to consider this relationship for at least 3 years or more, if the business maintains ROA>=10% and lasts at least 3 years, it is a good business. The increasing ROA trend shows that the business uses assets more efficiently.

It can be concluded about how good ROA is by the following formula:

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

## What is ROE?

ROE stands for Return on Equity, which is an indicator of return on equity. ROE is the ratio of profit to equity that a business uses in business activities to evaluate the efficiency of using capital.

### ROE Formula and Example

The ROE can be calculated using the following formula:

ROE = (Earnings after tax / Equity) * 100

In there:

• Profit after tax means the net profit after deducting related expenses.
• Equity is the company's own capital (not including borrowed capital).

Example: Enterprise has a profit after tax of VND 50 billion and equity of VND 150 billion. Then ROE = (50/150)×100 = 33%

### Meaning of ROE

ROE means 1 dollar of capital that a business spends to serve its activities and how much profit it makes. The higher the ROE, the more efficient the company's capital is.

## Analyzing the Link Between ROA and ROE

The link between ROA and ROE is shown by the formula for calculating financial leverage, specifically as follows:

Financial leverage = Assets / Equity = ROE/ROA.

Therefore, it can be seen that ROA and ROE are closely related, directly affecting the performance of the business. To better understand the correlation of ROA and ROE, it is recommended to rely on the Dupont analytical model.

The Dupont model is as follows:

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

Total Assets = Total Equity or (Total Debt + Equity).

It can also be deployed into the coefficient below to see that ROE is calculated based on the coefficient of net profit margin, financial leverage, and asset utilization efficiency.

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

The change of ROE can be seen due to many factors on profitability of revenue (interest rate, tax rate, ability to control costs, ...) ability to use assets (ability to generate income). income from using capital to finance assets in production and business, the ratio of using debt.

## Some notes when using ROA, ROE

ROA is an important indicator, but when using this indicator, it is necessary to keep the following points in mind:

• Before making a judgment about whether the ROA of that business is good or not, you need to pay attention to the industry in which the business operates, the ROA of competitors in the industry, and the ROA of the business in the past.
• To have a more comprehensive and accurate view of the financial position of your business, you need to combine ROA analysis with ROE, ROS and financial leverage.