An investment in a business should yield more than a bank certificate of deposit which should yield more than stuffing cash in your mattress. We need a way to compare the investment return across asset classes.
The profitability financial indicators for your business tell how much money your investment in company assets is returning. Generally people start or buy a business to make a profit.
There are two primary ways to measure a business investment return:
Return on Assets (ROA): The return on assets indicator shows the amount of net profit on each dollar of assets. The ROA ratio shows how productively the fixed and liquid assets are generating business profit.
Return on Equity (ROE): Some of those assets are purchased with equity and debt so the return on equity ratio reveals how much positive leverage the company is generating with borrowed funds. In other words ROE measures the return generated only by the equity investment in the assets. ROE will exceed ROA (positive leverage) if the loan interest rate is LESS than the ROA.
The goal is to generate a high enough return on the investment in the company to compensate for the risk and to match or beat the return of your industry competitors.