Financial Ratio - Return On Asserts

Financial Ratio - Return On Asserts

The Return on Equity (ROE) is a very important ratio, as it helps the investor assess the return the shareholder earns for every unit of capital invested. RoE measures the entity’s ability to generate profits from the shareholder's investments. In other words, RoE shows the efficiency of the company in terms of generating profits to its shareholders. Obviously, higher the RoE, the better it is for the shareholders. In fact, this is one of the key ratios that help the investor identify investable attributes of the company. To give you a perspective, the average RoE of top Indian companies vary between 14 – 16%. I personally prefer to invest in companies that have a RoE of 18% upwards.

This ratio is compared with the other companies in the same industry and is also observed over time.Also note, if the RoE is high, it means a good amount of cash is being generated by the company, hence the need for external funds is less. Thus a higher ROE indicates a higher level of management performance.

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

From the Annual Report, we know:

Net income for FY 14 = Rs.367.4 Crs

And we know from the Dupont Model the Total average assets (for FY13 and FY14) = Rs.1955 Crs So what does interest *(1- tax rate) mean? Well, think about it, the loan taken by the company is also used to finance the assets which in turn is used to generate profits. So in a sense, the debt holders (entities who have given a loan to the company) are also a part of the company. From this perspective, the interest paid out also belongs to a stakeholder of the company. Also, the company benefits in terms of paying lesser taxes when interest is paid out, this is called a ‘tax shield’.For these reasons, we need to add interest (by accounting for the tax shield) while calculating the

ROA.

The Interest amount (finance cost) is Rs.1 Cars, accounting for the tax shield it would be = 7* (1 – 32%)= 4.76 Crs. Please note, 32% is the average tax rate.

Hence ROA would be – ROA = [367.4 + 4.76] / 1955 ~ 372.16/ 1955 ~19.03%

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