Principles of Managerial Finance

CHAPTER 2 Financial Statements and Analysis 65

return on common equity (ROE)
Measures the return earned on
the common stockholders’
investment in the firm.

return on total assets (ROA)
Measures the overall effective-
ness of management in generat-
ing profits with its available
assets; also called the return on
investment (ROI).

Return on Total Assets (ROA)

The return on total assets (ROA),often called the return on investment (ROI),

measures the overall effectiveness of management in generating profits with its

available assets. The higher the firm’s return on total assets, the better. The return

on total assets is calculated as follows:

Return on total assets

Bartlett Company’s return on total assets in 2003 is

6.1%

This value indicates that the firm earned 6.1 cents on each dollar of asset

investment.

Return on Common Equity (ROE)

The return on common equity (ROE)measures the return earned on the common

stockholders’ investment in the firm. Generally, the higher this return, the better

off are the owners. Return on common equity is calculated as follows:

Return on common equity

This ratio for Bartlett Company in 2003 is

12.6%

Note that the value for common stock equity ($1,754,000) was found by sub-

tracting the $200,000 of preferred stock equity from the total stockholders’

equity of $1,954,000 (see Bartlett Company’s 2003 balance sheet in Table 2.2).

The calculated ROE of 12.6 percent indicates that during 2003 Bartlett earned

12.6 cents on each dollar of common stock equity.

Review Questions

2–12 What three ratios of profitability are found on a common-size income

statement?

2–13 What would explain a firm’s having a high gross profit margin and a low

net profit margin?

2–14 Which measure of profitability is probably of greatest interest to the

investing public? Why?

$221,000



$1,754,000

Earnings available for common stockholders



Common stock equity

$221,000



$3,597,000

Earnings available for common stockholders



Total assets