Margins ignore the balance sheet entirely. Two companies with identical 10% margins are utterly different businesses if one needs ₹5,000 cr of assets to produce ₹1,000 cr of sales and the other needs ₹200 cr. Return ratios divide profit by the money employed:
ROA = Net income ÷ Average total assets ROE = Net income attributable to parent ÷ Average shareholders' equity attributable to parent
What conventions make ROE and ROA reliable?
Four conventions turn these from formulas into professional instruments:
1. Average balances, always. Profit, the numerator, accrued over the whole year. Assets and equity, the denominator, are a photograph of one day. Divide a year of flow by the closing photo and every fast-growing company looks artificially bad, because the new capital arrived mid-year but is charged as if it were there all year. Every shrinking one looks good. The convention is Average = (opening balance + closing balance) ÷ 2. Use quarterly averages when you have them and the year is lumpy, say after a big acquisition or a rights issue. There's one deliberate exception, and you'll meet it again in Ratio Toolkit II. When you're screening for fresh deterioration, ending balances show the newest behavior. For measurement and comparison, use averages.
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2. Match the claimants: parent-only ROE. You've already seen, in Equity, SBC, Consolidation & the Rest, that consolidated net income includes the minority's share of subsidiary profits, and consolidated equity includes the NCI line. ROE must compare like with like, so it's profit attributable to owners of the parent ÷ average equity attributable to owners of the parent. Mix consolidated profit with parent equity (or the reverse) and you misstate ROE by the full minority wedge. It's a silent error, and a common one in quick screens.
3. Preferred claims come out first. For common-shareholder ROE under US GAAP, use (Net income − preferred dividends) ÷ average common equity. Under Ind AS and IFRS, most redeemable preference shares are classified as liabilities, so their "dividend" is already in finance costs and no adjustment is needed. Check the note before you adjust twice.
4. Know your ROA variant. Plain NI ÷ average assets is internally inconsistent. The numerator is after interest, a payment to debt-holders, but the denominator includes assets financed by debt-holders. Three responses coexist. Plain ROA is fine for casual use and for time series on one company. Adjusted ROA, (NI + interest expense × (1 − tax rate)) ÷ average assets, is the CFA convention. It adds back the after-tax cost of debt so the return is pre-financing. Operating ROA, EBIT ÷ average assets, is fully pre-financing and pre-tax. Use plain ROA inside DuPont, because the algebra requires it. Use the adjusted or operating variant when you compare companies with very different debt loads, or skip ahead mentally to ROIC, which resolves this properly.
When does ROE stop meaning anything?
ROE stops meaning anything when equity stops meaning anything. Equity is a residual that management can shrink toward zero: years of buybacks, write-offs, heavy dividends. Starbucks and Domino's Pizza have both reported negative book equity after sustained buybacks. Both are healthy, profitable businesses whose ROE is undefined. As equity shrinks, ROE inflates with no change in the business. That structural limit comes back in the limits of ROE and worked example 2, and it's half the reason analysts move on to ROIC.