medium · Financial Accounting financial-statement-analysis-ratios
Why is the standard Return on Assets (ROA) ratio considered biased for firms with significant debt in their capital structure?
- Assets sit on the books at historical cost, while reported net income reflects current-period purchasing power.
- The numerator (Net Income) is post-interest, while the denominator (Assets) is financed by both debt and equity.
- Total assets include non-operating items like cash, which distort the denominator regardless of financing mix.
- Depreciation is a non-cash expense embedded in the numerator that mechanically lowers income for all firms.
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