What are ROE and ROA? Let’s check the indicators of profitability analysis

Have you ever heard the words ROE and ROA?
ROE and ROA indicators are very important indicators for management. If you’ve heard of it, but don’t know the details, or don’t know how to use it, make sure to check it.

table of contents

  • What kind of management index is ROE (return on equity)? How should I use it?
  • What kind of management index is ROA (return on assets)? How should I use it?
  • How can I improve ROA and ROE?
    • Difference between ROA and ROE
    • To improve ROE
    • To improve ROA
  • Summary

What kind of management index is ROE (return on equity)? How should I use it?

ROE (Return On Equity) refers to the return on equity, and is an index that shows how much profit is being made by using the capital (equity capital) contributed by shareholders.
This return on equity is calculated using the following formula.

Return on Equity (ROE) = Net Income / Equity x 100

The company operates with the capital invested by the shareholders. From the perspective of shareholders, it is better to use the invested capital efficiently and make a lot of profits. By comparing ROE between companies, you can see who is making a profit efficiently.

For example, let’s look at ROE at the following two companies.

Company A Net income 1 billion yen Equity 10 billion yen
Company B Net income 200 million yen Equity 1 billion yen

Company A’s ROE is 10% (calculation formula: 1 billion yen ÷ 10 billion yen).
The ROE of Company B is 20% (calculation formula: 200 million yen ÷ 1 billion yen).

Comparing company A and company B simply by profit alone, it seems that company A is better because company A records more net income. However, looking at ROE, it can be seen that Company B is higher and is making profits efficiently (capital efficiency is good). If you invest the same amount, you can judge that the return is larger if you invest in Company B.

ROE is a management index for judging efficiency that cannot be understood only by the large amount of profit and the small amount of profit. Naturally, the higher the return on equity, the higher the evaluation from shareholders.

It was said that Japanese companies have low ROE, but in recent years, management with an emphasis on shareholders has been required, and improvements have progressed, with the average exceeding 10%. This 10% is one guideline, and 15% is good.

 

What kind of management index is ROA (return on assets)? How should I use it?

ROA (Return On Assets) refers to the return on assets, and is an index that shows how much profit is being made by using the assets that the company has. Return on total assets is calculated using the following formula.

Return on total assets (ROA) = Net income / Total assets x 100

For example, let’s look at ROA at the following two companies.

Company A Net income 1 billion yen Total assets 20 billion yen
Company B Net income 1.5 billion yen Total assets 25 billion yen

The ROA of company A is 5% (calculation formula: 1 billion yen ÷ 20 billion yen).
The ROA of Company B is 6% (calculation formula: 1.5 billion yen ÷ 25 billion yen).

If both Company A and Company B are in the same industry, it can be said that Company B, which has a high ROA, is able to utilize its assets more efficiently and earn profits. In this way, ROA is also an index for judging the efficiency of profit acquisition, and the higher it is, the better.
The standard ROA level varies depending on the type of industry, but it is generally said that 5% is one standard. ROA is not suitable for comparisons between different industries, as the guidelines vary by industry.

Total assets also increase in industries that require large equipment such as factories. On the other hand, if there is no need for large capital investment as in the IT industry, total assets will not be so large. Comparing these, ROA is lower in industries that require capital investment, but that does not mean that investment in such industries is not good and should be invested in the IT industry.

ROA should be used to judge the superiority or inferiority of other companies in the same industry, or to check the status of improvement by looking at changes in the same company by year.

How can I improve ROA and ROE?

Difference between ROA and ROE

ROA and ROE are very similar, but there are differences in the denominator of the formula. ROE is the denominator that uses equity capital, and ROA is the denominator that uses total assets.

ROE is a return on equity, so it can also be used when comparing between different industries. On the other hand, ROA is a return on total assets, so it is not suitable for comparison between different industries as mentioned above.

To improve ROE

In order to improve ROE, it is necessary to increase the numerator, net income, or reduce the denominator, equity capital. For example, if you have a lot of surplus funds, you can reduce your equity capital by reducing your capital or buying back your own shares. Also, if you are in debt-free management, you should take a driving loan and reduce your equity capital by reducing the capital or buying back your own shares in the same way for unnecessary funds. You may be reluctant to borrow money, but from the perspective of making effective use of shareholders’ money, borrowing money is one way to do it.

To improve ROA

In order to improve ROA, it is necessary to increase the numerator, net income, or reduce the denominator, total assets. There are various ways to increase profits depending on the company. In order to reduce total assets, reduce inventories, dispose of stagnant receivables, sell unnecessary equipment, cancel investments that are not related to business, etc., cash unnecessary assets and repay debt It is possible to reduce the size of assets by doing so.

Summary

I explained ROE and ROA, which are also important management indicators. In recent years, it has been required to manage not only to make a lot of profits but also to improve the efficiency of capital and assets. If ROE and ROA are low, it may affect the stock price of the company. Let’s keep in mind the efficiency of capital and assets by utilizing ROE and ROA.

 

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