ROE, ROA, and ROCE How to calculate with examples

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Net Sales / Average Total Assets = Asset Turnover 

The ARBL’s FY14 Annual Report reveals that net sales amounted to Rs.3437 Crs.

We can find the Average Total Assets on the Balance Sheet. The term ‘Average’ implies that we are looking at the mean figure of an amount over a period of time.

At the onset of FY14 (1st April 2013), ARBL had a certain amount of assets carried over from the preceding year (FY2013). During the financial year, they added on to this initial amount and ended up with total assets by the end of FY14, amounting to Rs.2139 Crs. It can be seen that their closing figure was vastly different from their position at the start of 2014.

In order to calculate the asset turnover ratio, I should take an average of the asset values from both the current and previous years. That is the standard procedure to avoid any confusion.

It is important to commit this averaging method to memory, as it will be applied in other calculations.

From ARBL’s annual report, we know:

In the fiscal year 2014, the Net Sales of Amara Raja amounted to Rs.3437Cr. As for the Total Assets, it was Rs.1770 Cr in FY13 and increased to Rs.2139 Cr in FY14. To calculate the Average Assets, we add the values of FY13 and FY14 and divide by 2, resulting in an average of 1955.

Asset Turnover = 3437 / 1955

= 1.75 times

For every rupee of invested asset, the company is earning 1.75 rupees in revenues.

Let’s compute the Financial Leverage now.

Average Total Assets / Average Shareholders Equity = Financial Leverage 

It’s clear that the average total assets amount to Rs. 1955. Investigating shareholder equity requires a similar approach; rather than simply looking at the current year, we will consider the “Average Shareholder Equity”.

In FY13, the Shareholder’s Equity stood at Rs.1059 Crs, and in FY14, it increased to Rs.1362 Crs.

Average shareholder equity = Rs.1211 Crs

Financial Leverage = 1955 / 1211

= 1.61 times

Looking at ARBL’s Financial Leverage of 1.61, it is clear that for every Rupee of Equity, the company backs up Rs.1.61 of assets. This is indeed an encouraging figure in light of their low debt.

Now that we have all the information needed to calculate ARBL’s Return on Equity, let’s begin.

Net Profit Margin X Asset Turnover X Financial Leverage = RoE 

= 9.2% * 1.75 * 1.61

~ 25.9%. Quite impressive, I must say!

I comprehend this is an extended route to compute RoE, yet it is by all accounts the most productive way for us to gain valuable insights into the business. The DuPont model not only gives us an answer concerning how much the return is, but additionally its quality.

If you desire to do a speedy RoE calculation, you can use the following method:

Net Profits / Avg shareholders Equity = RoE

By referring to the annual report, we can determine that the Profit After Tax (PAT) for FY14 is Rs.367 Cr.

 

RoE = 367 / 1211

= 30.31%

Return on Asset (RoA):

With a firm understanding of the DuPont Model, grasping the following two ratios should be straightforward. Return on Assets (RoA) reviews an organisation’s success in profiting from their assets. Wisely managed entities limit resources invested in non-productive assets, whereas RoA highlights management proficiency in deploying its belongings. Of course, a higher ROA is preferable.

[Net income + interest*(1-tax rate)] / Total Average Assets = RoA

From the Annual Report, we know:

The net income for FY14 is recorded as Rs.367.4 Crs.

According to the Dupont Model, we have information about the average total assets for both FY13 and FY14, which amounts to Rs.1955 Cr.

So what does interest *(1- tax rate) mean? Considering the loan taken by the business, it is used to finance assets that create profits. Therefore, the debtholders could be seen as part of the company. For this reason, the interest paid out should also be thought of as belonging to a stakeholder of the company. Not only that, but paying interest on debt is beneficial for the company in terms of lower taxes; referred to as a tax shield. Therefore, considering all these factors, we must account for it while determining ROA.

Taking into account the tax shield, the interest amount (finance cost) is Rs.7 Crs.

= 7* (1 – 32%)

= 4.76 Cr. Please note, 32% is the average tax rate.

Hence ROA would be –

RoA = [367.4 + 4.76] / 1955

~ 372.16 / 1955

~19.03% 

Return on Capital Employed (ROCE):

The Return on Capital employed furnishes an indication of the company’s profitability, bearing in mind all the capital utilized.

Overall capital includes both equity and debt, long-term and short-term.

Profit before Interest & Taxes / Overall Capital Employed = ROCE 

Overall Capital Employed = Short-term Debt + Long-term Debt + Equity.

From ARBL’s Annual Report, we know:

Profit before Interest & Taxes = Rs.537.7 Crs

Overall Capital Employed:

Short term debt: Rs.8.3 Cr

Long term borrowing: Rs.75.9 Cr

Shareholders equity = Rs.1362 Cr

Overall capital employed is: 

1446.2 Crs = 8.3 + 75.9 + 1362

ROCE = 537.7 / 1446.2

= 37.18%

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