CFA Level 1

AAA

Financial Ratios - Return on Investment Ratios

II. Return on Investment

1. Return on Assets (ROA)
This ratio measures the operating efficacy of a company without regards to financial structure

Formula 7.21

Return on assets = (net income + after-tax cost of interest)
average total assets

OR

Return on assets = earnings before interest and taxes
average total assets

Where:
Average total assets = (previously reported total assets + current total assets)
2

2. Return on Common Equity (ROCE)
This ratio measures the return accruing to common stockholders and excludes preferred stockholders.

Formula 7.22

Return on common equity = (net income - preferred dividends)
average common equity

Where:
Average common equity = (previously reported common equity + current common equity) / 2

3. Return on Total Equity (ROE)
This is a more general form of ROCE and includes preferred stockholders.

Formula 7.23

Return on total equity = net income
average total equity

Where:
Average common equity = (previously reported total stockholders' equity + current total stockholders\' equity) / 2

4. Return on Total Capital (ROTC)
Total capital is defined as total stockholder liability and equity. Interest expense is defined as the total interest expense excluding any interest income. This ratio measures the total return the company generates from all sources of financing.

Formula 7.24

Return on total capital = (net income + interest expense)
average total capital


Operating Efficiency Ratios
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