ABC Ltd reported a decline in the creditors as cash was paid to them. What will be the impact of this on the RoE and RoA of ABC Ltd?

Solution

Return on Equity (RoE) = Net Profit / Networth of the company As per accrual accounting, the transactions are recorded in the income statement based on when they occur and not based on the actual cash movement. As such, the net profit is not affected /changed when actual payment is made to the creditors. Thus the RoE remains unaffected by the above transaction. However, a payment to the creditors indicates a decline in the cash and also in the creditors. Thus, the total assets of the company fall. Since Return on Assets (RoA) = Net Profit / total assets of the company, a decline in the total assets will improve the RoA, other things remaining the same.