Corporate finance
What are ROE and ROA?
ROE is net income relative to average shareholders' equity; ROA is net income relative to average total assets.
Definition
ROE is net income relative to average shareholders' equity; ROA is net income relative to average total assets.
Intuition
Both use the same profit numerator; one views shareholder capital and the other all assets employed.
Formula
ROE divides net income by average equity; ROA divides it by average total assets for the same period.
Variables and average balances
Net income is earned over a period. Average equity and assets commonly average opening and closing balances, reducing dependence on one reporting date.
When to compare and limits
Use these ratios across periods or as a starting point among peers. Accounting policies, leverage, and business models limit direct cross-company comparisons.
Example
- Enter net income 120, average equity 600, and average assets 1,000.
- ROE = 120 ÷ 600 = 20%; ROA = 120 ÷ 1,000 = 12%.
- The eight-percentage-point gap may reflect debt funding; inspect leverage and earnings quality before drawing conclusions.
Common mistakes
Do not compare ROE alone while ignoring debt, one-off earnings, or industry asset intensity.
Frequently asked questions
How are average balances calculated?
A common approximation averages opening and closing balances. For large intra-period changes, use more frequent observations. Align the balance period with net income.
Why can ROE exceed ROA?
Debt financing can make equity smaller than total assets. Borrowing costs and risk also matter.
Can ROE be interpreted with negative equity?
Zero or negative equity makes the conventional ratio misleading. This tool requires positive average equity and assets.