How to use it
- Choose the 3-step or 5-step model.
- Enter net income and revenue from the income statement.
- Enter total assets and equity, preferably averages for the year.
- For the five-step model, add profit before tax and operating profit (EBIT).
Formula
Three-step: ROE = (NI ÷ revenue) × (revenue ÷ assets) × (assets ÷ equity)
Five-step: ROE = (NI ÷ EBT) × (EBT ÷ EBIT) × (EBIT ÷ revenue) × (revenue ÷ assets) × (assets ÷ equity)
ROA = NI ÷ assets = net margin × asset turnover.
Worked example
Net income 120,000, revenue 1,500,000, assets 1,200,000, equity 500,000:
- Net margin = 8 %, asset turnover = 1.25, equity multiplier = 2.4.
- ROE = 0.08 × 1.25 × 2.4 = 24 %; ROA = 10 %.
With EBT of 160,000 and EBIT of 200,000: tax burden 0.75, interest burden 0.8, operating margin 13.33 %; 0.75 × 0.8 × 0.1333 × 1.25 × 2.4 gives the same 24 %.
Tips
- Compare the factors over several years: a rising ROE driven only by the equity multiplier means more debt, not a better business.
- Retailers tend to have low margins and high turnover; asset-heavy businesses the opposite.
- With negative equity ROE is meaningless; the calculator asks for equity above zero.