Question

Define and differentiate between return on total assets (ROA), return on equity (ROE), and earnings per share (EPS). Which measure is probably of greatest interest to owners? Why?

Answer 1

Return on total assets (ROA);

Return on total assets (ROA) is a financial ratio which helps in measuring the profitability of a firm. In other words we can say that ROA helps in knowing the relationship between net income and total assets.

ROA tells that how much returns have been generated on the total assets during an accounting period.

Return on equity (ROE);

Return on equity (ROE) is a financial ratio which helps in measuring the profitability of a firm. In other words we can say that ROE helps in knowing the relationship between net income and equity.

ROE tells that how much returns have been generated on the total equity during an accounting period. Hence we can say both ROA and ROE are different because ROA helps in knowing rate of return on total assets (whether it is funded by debts or equity) whereas ROE helps in knowing rate of return on equity funds only.

Earnings per share (EPS);

Earnings per share (EPS) helps in knowing about the returns given to the real owners of a firm. In other words we can say that it shows that how much per share earnings the real owners will receive at the end of an accounting period.

EPS shows the relationship between net income after preference dividend and outstanding shares. Thus this is very minor study of profitability in an accounting period because it shows how much real owners will receive actually.

Which measure is probably of greatest interest to owners?

EPS is the measure, which is probably of greatest interest to owners because real owner just want to know that how much they will receive from invested money. As we know that common stockholders are the real owner and EPS shows that how much these real owners will receive on their investment per share that is why EPS is probably of greatest interest of owners. Although ROA and ROE also very useful for owners but we also know that owners do not have much time and much depth understanding about all financial & profitability ratios that is why owners will simply understand their returns with the help of EPS.