Accounting and Finance for Decision Making: ROA vs ROE Analysis Report

This report delves into the comparison between Return on Assets (ROA) and Return on Equity (ROE) as performance indicators in accounting and finance. It begins by introducing how financial tools facilitate decision-making, specifically focusing on ROA and ROE. The main body of the report discusses the calculation and interpretation of both ROA and ROE, highlighting their individual strengths and weaknesses. ROA measures earnings generated from assets, while ROE focuses on shareholder investment returns. The report then contrasts ROA and ROE, emphasizing the impact of financial leverage and operational management. Finally, it critically evaluates whether ROA is a superior performance measure compared to ROE, considering potential financial distortions and the broader scope of judgment. The conclusion summarizes the findings, suggesting that ROA offers a better scope for identifying performance and asset allocation efficiency. The report is supported by references to academic journals and online resources.

ACCOUNTING AND FINANCE
FOR DECISION-MAKING

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
CONCLUSION................................................................................................................................1
REFERENCES................................................................................................................................2

INTRODUCTION
The various tools and techniques in the arena of accounts and finance are used to
facilitate the decision-making process of the company. The financial information that is
generated by the preparation of the financial statements shall be applied to the different tools to
formulate the strategic decision-making in the business pertaining to the future business
operations. The current project shall be discussing over the two performance indicators which are
return on assets and return on equity. Further it shall be highlighting with several arguments that
whether the return on assets is a better performance measurement than return on equity.
MAIN BODY
Return on Assets
The return on assets ratio shall be measuring the earnings that are generated over the each
dollar of the assets that are invested in the business. It can involve all the assets of the company
like the cash, receivables, furniture, investments etc. It helps in knowing the returns that are
generated by the capital invested in the business. It can be inferred as the measure to know the
financial performance of the business (Agrawal, Mohanty and Totala, 2019). It is calculated by
dividing the net earnings plus the interest expense by the total assets of the company. It is a
financial metric that is generally used to know the efficiency of the management to employ its
various resources financial as well as non-financial to generate the returns for the company.
Higher is the return on asset ratio the better is the performance of the business convincing the
investors that the company efficiently invest the sum so that the earnings generated on it can be
maximized fulfilling the profitability motive of the company.
Return on Equity
The return on equity is another measure of the company's financial performance as it
shall indicate the profit generated by investing the amount of shareholders investment in the
company. It measures how effectively the investments of the shareholder are reinvested so that
higher returns can be generated in the company. The company with the higher ROE shall be
preferred as its efficiency can be known and also that sufficient cash shall be generated internally
which is rather advisable to be invested in as it can further extend such benefits towards the
shareholders of the company (Maeenuddina and et.al., 2020). It can also be regarded as the
management efficiency to employ the funds as received by the shareholders in the better
investment alternatives maximising the overall earnings that are generated in the company.
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Difference between the ROA and ROE
One of the most significant differences that can be identified between return on assets and
the return on equity ratio is the financial leverage and debt factor of the company (Batchimeg,
2017). The calculation of return on equity involves the equity sources of fund which is the
shareholders fund but completely ignores the debt portion of the business. On the contrary it can
be evidently seen that in the calculation of return on assets the total asset amount is calculated by
adding the liabilities and the shareholders fund of the business. This means that it completely
involves the debt element in its calculation. This is one of the merits for the return on assets as it
involves the debt factor of the business. The other significant difference could be that the return
on equity focuses on financial management but on the other hand the return on assets governs the
operational management. The return on equity shall be determining the earnings that are
generated only on the investments made by the shareholders whereas it can be evaluated that the
return on assets shall be considering the profitability that is generated on the overall resources
that are applied in the business operations (Pointer and Khoi, 2019). So it can be analysed that
the return on assets has the wider perspective to determine the efficiency of the company as
compared to the return on equity.
Is ROA a better performance measurement than ROE
There are various financial metrics that have been developed to enquire about the
company performance and the efficiency with which they are conducting the business
operations. Among those are the return on equity and the return on assets which provide the idea
regarding the same, but its essential to know that which is the better measurement for
performance.
It can be assessed that return on equity is one of the essential ratio to measure the
performance and definitely more enduring than the measures like IRR or the DCF model. But it
can also be noticed that such ratio can be artificially maintained in the company (Asikin, Saudi
and Roespinoedji, 2020). This can be through growing the financial leverage in the company and
using the accumulated funds to feature buy back in the stock market. This technique shall be
maintaining the return on equity at its similar level. Apart from that it can also be considered that
since the return on equity does not consider the debt ad the financial leverage element of the
business, so its possible that it can cause any of the financial distortions through not considering
the potential financial obligations of the business.
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It can be evaluated that return on assets which is not a much popular measure can
relatively be considered as the better measure for the performance as it shall not be eligible for
any of the financial distortions in the company (The Best Way to Measure Company
Performance, 2021). Also it has wider scope of judgement and can better analyse the operational
efficiency with which the business is conducted employing the resources with highest possible
effectiveness to generate the maximum possible returns for the company.
CONCLUSION
From the above project it can be summarized that all the financial metrics analysing the
performance of the business and the efficiency with which the management is employing the
funds have some pros and cons in its applications. But it can be concluded that return on assets
ratio in the company have the better scope of identifying the performance as well as the optimum
allocation of the assets of the business to generate the earnings for the company. The return on
equity lags behind in the fact that neither does it consider the financial leverage nor its safe from
any financial distortions.
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REFERENCES
Books and Journals
Agrawal, A., Mohanty, P. and Totala, N. K., 2019. Does EVA beat ROA and ROE in explaining
the stock returns in Indian scenario? An evidence using mixed effects panel data
regression model. Management and Labour Studies. 44(2). pp.103-134.
Maeenuddina, R. B. and et.al., 2020. Economic Value Added Momentum & Traditional
Profitability Measures (ROA, ROE & ROCE): A Comparative Study. TEST-Engineering
and Management. 83. pp.13762-13774.
Batchimeg, B., 2017. Financial performance determinants of organizations: The case of
Mongolian companies. Journal of competitiveness. 9(3). pp.22-33.
Pointer, L. V. and Khoi, P. D., 2019. Predictors of Return on Assets and Return on Equity for
Banking and Insurance Companies on Vietnam Stock Exchange. Entrepreneurial Business
and Economics Review. 7(4). pp.185-198.
Asikin, B., Saudi, M. H. and Roespinoedji, R., 2020. Influence of Return on Assets (ROA),
Return on Equity (ROE), and Earning Per Share (EPS) of Stock Price (Survey on
Corporate Advertising, Printing, and the Media listed on the Indonesia stock exchange
Period 2015-2019). Solid State Technology. 63(3). pp.3941-3955.
Online
The Best Way to Measure Company Performance. 2021. [Online] Available through:
<https://hbr.org/2010/03/the-best-way-to-measure-compan.html>
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