Three ratios, one pack

Return on assets

Return on assets asks how much income the company earned on everything it controls, however that was financed:

$$\text{ROA}=\frac{\text{Net income}}{\text{Average total assets}}=\frac{480}{3,700}=12.97\%$$

Every dollar of assets Tamarack held through 2025 earned about thirteen cents. Read it against last year, against a competitor, and against what the assets cost to finance (lesson 9.3).

Some finance texts define ROA as EBIT ÷ total assets — an operating ROA that ignores how the assets were financed and taxed. It is a legitimate variant, and you should recognise it when an analyst’s report uses it; this course computes and grades the net-income version.

Return on equity

Return on equity asks the question the common shareholder cares about: what did the company earn on my money?

$$\text{ROE}=\frac{\text{Net income}-\text{Preferred dividends}}{\text{Average common equity}}=\frac{480-0}{2,000}=24.00\%$$

Tamarack has no preferred shares, so the numerator is all of net income and the denominator is all of equity. Two adjustments appear the moment preferred shares exist, because preferred shareholders have a prior claim on both income and equity:

• subtract the preferred dividends from net income, because that income is not the common shareholders’;
• subtract the preferred share capital from equity, because that capital is not theirs either.

Suppose Tamarack had 100 of preferred shares within its 2,200 of closing equity and its 1,800 of opening equity, and paid 20 of preferred dividends in 2025. Average common equity becomes 2,000 − 100 = 1,900, and

$${\text{ROE}}_{\text{common}}=\frac{480-20}{1,900}=24.21\%$$

Both adjustments go the same way, so forgetting one of them is the exam’s standard trap: (480 − 20) ÷ 2,000 = 23.0 % and 480 ÷ 1,900 = 25.3 % are both wrong.

Asset turnover

Asset turnover is not a return at all; it measures how hard the assets work, in dollars of revenue per dollar of assets:

$$\text{Asset turnover}=\frac{\text{Revenue}}{\text{Average total assets}}=\frac{4,800}{3,700}=1.297$$

Tamarack generated $1.30 of sales for every dollar of assets it held on average. A grocery chain turns its assets three or four times a year on thin margins; a utility turns them once every few years on fat ones. Lesson 9.3 shows that ROA is exactly margin multiplied by turnover, which is why the two are read together.

The 2024 comparison

To compute the same three ratios for 2024 you need the 31 December 2023 balance sheet as the opening balance. Suppose it showed total assets of 3,000 and equity of 1,500. Then average assets for 2024 are (3,000 + 3,400) ÷ 2 = 3,200, average equity (1,500 + 1,800) ÷ 2 = 1,650, and: ROA 330 ÷ 3,200 = 10.31 %; ROE 330 ÷ 1,650 = 20.00 %; asset turnover 4,000 ÷ 3,200 = 1.25. All three rose in 2025 — the company earned more on its assets, more on its shareholders’ money, and squeezed more sales out of each dollar of assets. That sentence, with the numbers, is the interpretation the final asks for.