What Is Return On Equity?
Return on Equity (ROE) is a percentage representation of a firm’s yearly return (total revenue) divided by the value of its entire shareholders’ equity. This percentage is important because it tells stakeholders how well a company uses its assets to make money.
It combines the income statement and balance sheet, where net income or profits is compared to shareholders’ equity, Return on Equity is a two-part measure. The overall return on equity capital is a measure of a company’s ability to transform its equity stake into profits. To put it another way, it calculates how much income each dollar from shareholders’ equity generates.
For owners and investors, return on equity gives insight into the profitability of your organization. In a nutshell, it aids investors in determining if they’re getting a fair return on their investment, and it’s also a wonderful tool to assess how well your company can use its equity. Furthermore, the return on equity formula may be used to calculate your company’s long-term growth rates.
The equation to evaluate the ROE of a company is Net Income / Shareholders’ Equity
Net income refers to your company’s bottom-line earnings (before dividends are distributed to common shareholders) as recorded on your financial statements in this return on equity calculation. By deducting liabilities from revenues, you may estimate your shareholder equity.
While useful, ROE should not be considered as the only indicator of a firm’s overall financial health or future. There are a variety of ways why the ROE calculation might be deceptive when used alone. For example, a firm that borrows excessively would falsely boost its ROE since whatever debt it takes on decreases the denominator of the ROE calculation.
Return On Equity Example
A sportswear firm is a retailer that specializes in activewear for athletes. During the year, the firm earned $10,000 in net earnings and paid $5,000 in preferred dividends. During the year, they also had 5,000 per $5 common shares outstanding. Her return on common equity was determined by the firm to be 0.8
This indicates that for every dollar of average shareholder ownership, $0.8 was earned this year. In other terms, investors received an 80% return on their investment. For this industry, the business ratio is deemed high. This result suggests that the firm is expanding.« Back to Glossary Index