What Are The Important Financial Ratios To Look At? (Part 1)

Return On Assets – ROA

This indicates how the company is using its assets to generate income. It is calculated by dividing its net income against total assets. For example,

Net Income = $1,000,000
Value of total assets = $3,500,000
ROA → $1,000,000 / $3,500,000 * 100 = 28.57%

The higher the ROA, the better it is. If you are to do a comparison between companies within the same industry.

Company A Company B
Net Income $1,000,000 $1,000,000
Value of total assets $3,500,000 $7,000,000
ROA 28.57% 14.29%

It will be a better choice to consider invest with Company A, because it is generating more income with lesser assets.

Return On Equity – ROE

This indicates how the company is using its shareholders’ money to generate income. It is calculated by dividing its net income against shareholder’s equity.

Shareholders’ equity is calculated by deducting total liabilities from total assets.

For example,

Total Liabilities (Debt) = $1,000,000
Total Assets = $2,500,000
Net Income = $200,000
Shareholders’ equity –> $2,500,000 – $1,000,000 = $1,500,000
ROE → $200,000 / $1,500,000 * 100 = 13.33%

The higher the ROE, the better it is. 

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