Return Ratios
Return Ratios and DuPont Analysis
This lesson connects ROA, ROCE, ROE, and DuPont Analysis to explain how profit, asset use, and leverage create shareholder returns.
Concept First
Learn It Step By Step
Start with the business meaning, then move into the formula.
How should I read ROA?
ROA asks how much profit is generated from the asset base. If Company A earns PAT of Rs. 12 on assets of Rs. 100, ROA is 12%. Company B earns the same PAT on assets of Rs. 200, ROA is 6%. A is using assets more productively. Higher is generally better, but compare within industry because a bank, factory, retailer, and software company use very different asset models.
What is Capital Employed?
Capital Employed is the long-term money used in the operating business. A practical balance-sheet way to calculate it is Total Assets minus Current Liabilities. Another way is Shareholders' Equity plus long-term debt. Both approaches try to capture the capital that management must use productively to earn operating profit. Example: if total assets are Rs. 500L and current liabilities are Rs. 120L, capital employed is Rs. 380L. If equity is Rs. 230L and long-term debt is Rs. 150L, it is also Rs. 380L.
How should I read ROCE?
ROCE asks whether capital employed is earning a good operating return. The numerator is EBIT because we are testing operating profit before financing choices. The denominator is capital employed, the long-term capital used in operations. If EBIT is Rs. 30 and capital employed is Rs. 150, ROCE is 20%. If another company earns the same EBIT on capital employed of Rs. 300, ROCE is 10%. Higher is better because management is earning more from the capital entrusted to the business.
How should I read ROE?
ROE asks how much profit shareholders earn on their equity. If PAT is Rs. 25 and equity is Rs. 100, ROE is 25%. If PAT is Rs. 25 and equity is Rs. 200, ROE is 12.5%. Higher looks better, but ROE can be boosted by high debt. So never stop at ROE; ask what created it.
How does DuPont explain ROE?
DuPont says ROE comes from three forces: net margin, asset turnover, and equity multiplier. Company A may earn high ROE because it has strong margins. Company B may earn the same ROE because it uses heavy debt and has a high equity multiplier. The final ROE may be equal, but the quality and risk are not equal.
Which return ratio is best?
ROA is useful for asset productivity. ROCE is useful for operating return on long-term capital. ROE is useful for shareholder return. DuPont is useful for explaining ROE. A good business usually shows strong returns without depending only on leverage. Higher returns are better only when they are sustainable and not created by excessive financial risk.
Formula Lab
Understand the Formula
Read the formula like a business sentence before calculating it.
Formula 1
ROA = PAT / Average Total Assets
Formula 2
ROCE = EBIT / Capital Employed
Formula 3
ROE = PAT / Average Shareholders' Equity
Formula 4
DuPont ROE = Net Profit Margin x Asset Turnover x Equity Multiplier
Solved Case Study
Read the Numbers Like an Analyst
Work through one business case slowly: understand the situation, calculate the ratios, then interpret what the numbers are really saying.
Case context
A Bengaluru company has revenue Rs. 2,000L, PAT Rs. 200L, EBIT Rs. 300L, average assets Rs. 1,600L, capital employed Rs. 1,200L, and average equity Rs. 800L. ROA is 12.5 percent, ROCE is 25 percent, and ROE is 25 percent. DuPont also gives ROE: 10 percent net margin x 1.25x asset turnover x 2.0x equity multiplier = 25 percent.
Case: Same ROE, different quality
Company A has revenue of Rs. 1,000L, PAT of Rs. 120L, EBIT of Rs. 160L, average assets of Rs. 800L, current liabilities of Rs. 180L, and average equity of Rs. 500L. Company B has revenue of Rs. 1,500L, PAT of Rs. 120L, EBIT of Rs. 160L, average assets of Rs. 1,500L, current liabilities of Rs. 300L, and average equity of Rs. 500L.
Calculate ROA, ROCE, and ROE
ROA reads profit against assets. ROCE reads operating profit against capital employed. ROE reads profit against shareholder equity.
Both companies have the same ROE, but A earns much more profit per rupee of assets and per rupee of capital employed.
Open ROE using DuPont
DuPont shows whether ROE comes from margins, asset turnover, or leverage.
A's ROE comes from stronger margin and asset productivity. B's same ROE depends heavily on leverage.
Read the conclusion
The same ROE does not mean the same business quality. A is usually better because it earns the same shareholder return with less balance-sheet leverage. B may be riskier if debt is high or earnings are volatile.
Interpretation
What This Means In Practice
Read the result as a business signal, not as a standalone number.
How to read this
Return ratios ask whether the business earns enough from the resources entrusted to it. ROA reads profit against total assets. ROCE reads operating profit against long-term capital used in the business. ROE reads final profit against owners' funds. DuPont then opens ROE into three drivers: margin, asset turnover, and leverage. Start with the business meaning, then check the trend, peer benchmark, source line items, and cash impact.
What to remember
A high ROE is not enough. The finance professor's question is: did it come from strong margins, efficient asset use, sensible leverage, or excessive borrowing risk?
Key Takeaway
A high ROE is not enough. The finance professor's question is: did it come from strong margins, efficient asset use, sensible leverage, or excessive borrowing risk?
Practice Checkpoint
Check Your Understanding
Work through the quiz in smaller sets. Your answers stay visible while this page is open, so you can review before moving on.
Question 1 of 20
Level 1What does ROA compare?
Question 2 of 20
Level 1What does ROCE usually use in the numerator?
Question 3 of 20
Level 1What does ROE measure?
Question 4 of 20
Level 1What are the three DuPont drivers of ROE?
Question 5 of 20
Level 2PAT is Rs. 200L and average total assets are Rs. 1,600L. What is ROA?
15 questions remaining in this lesson.
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Ratio Analysis - An Introduction
Ratio Analysis Foundations
Knowledge Path
Connected Concepts
10 linked lessons
P&L Foundations
PBT, Tax and PAT
P&L Foundations
Operating Profit or EBIT
Balance Sheet Foundations
Total Assets
Balance Sheet Foundations
Current Liabilities
Balance Sheet Foundations
Shareholders' Equity
Balance Sheet Foundations
Long-Term Debt
Profitability Ratios
Profitability Margin Ratios
Efficiency Ratios
Efficiency and Turnover Ratios
Solvency Ratios
Solvency and Debt Service Ratios
Ownership Ratios