Institutional Information Systems (5 points) Two major profitability indicators from financial statements include the rate of...
- Institutional Information Systems (5 points)
Two major profitability indicators from financial statements include the rate of return on assets (ROA) and the rate of return of equity (ROE); that is, ROA = (Net Income/Average Assets) and ROE =Net Income/Average Equity Capital.
- Suppose ROA is 1.37%., explain the meaning of such measurement.
- If ROE is 14%, what is the meaning?
Homework Answers
First of all lets understand funding of asset. Asset are either financed by equity or debt or both. if asset are financed by equity than there will be no difference between ROE and ROA , difference is because asset is financed otherwise.
Now if ROA is 1.37% then it indicates that the asset is generating income equal to 1.37% of it's value.
If ROE is 14% then it indicates that on equity, return of 14% is being made. This return is often compared with risk free rate of return market is offering
Thus primary difference between ROA and ROE is financial leverage or debt. By taking debt company increases asset and thus ROE will rise above ROA
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Two major profitability indicators
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