Why does ROA use net income?
I understand that ROE uses net income because the net income is available to shareholders (equity). But ROA is regarding assets, so shouldn’t the return on assets be a pre-interest figure? If we wanted to use net income, we should exclude liabilities and use the equity which is what ROE is...
Because assets can be financed with debt. If you borrow money to buy a new piece of equipment, the interest is essentially part of the cost of owning that asset and should be factored into its return.
I’m sure there are some situations where an investor would add back interest expense to the ROA formula though.
My intuition; because assets are used to create “future economic value” and a solid measure of tangible value creation is net income. I could see cash flow or EBITDA being used as a numerator instead of net income to align with the whole “apples to apples” idea, but debt-holders are already looking at leverage and coverage ratios anyway. Plus, you can’t just eat cash flow forever. At some point the business needs to bring home some bacon.
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