What are some reasons why ROE is higher than ROA?

Question

Question

Answer 1

Answer #1

ROE would be higher than ROA when the company has debt on its books, i.e, part of its assets is financed by debt.

ROA = Net Profit Margin x Asset Turnover = Net Income / Net Sales x Net Sales / Total Assets

ROE = ROA x Equity Multiplier = ROA x Total Assets / Stockholders' Equity

If there is no debt or financial leverage, all assets are financed by equity. Hence equity multiplier equals 1, and ROE = ROA

However, if the company has outside liabilities, equity multiplier will exceed 1 as total assets would be more than total equity.

In such situations, ROE > ROA.

Answer 2

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