Return on Equity Formula (Table of Contents)
- Return on Equity Formula
- Return on Equity Calculator
- Return on Equity Formula in Excel (With Excel Template)
Return on Equity (ROE) Formula
From an investor’s point of view, it is important to know how much return is generated on his investment. There are various ways to see the investment return like return on equity, return on asset, return on capital employed, margins in the business. Return on Equity is apt for measuring the return on an investor’s money as it gives a percentage return generated on shareholder’s equity. Let’s see Return on Equity in detail.
Measure part of financial performance is a return of equity from a shareholder’s point of view. As shareholders’ equity is nothing but a company’s assets less its liabilities,
Shareholder’s Equity = Total Assets – Total Liabilities
Returns of equity formula can be calculated as net income divided by shareholders’ equity.
Return of equity is expressed in a percentage (%) unit and has the ability to calculate for any type of company with its net income, and average shareholder’s equity is positive if net income or shareholder’s equity are stated as negative numbers return on equity cannot be calculated. Return on equity is different for different sectors; the textile sector will be having a different return on equity than the information technology sector. So it is the investor’s choice to make an investment into the particular sector to get benefitted.
When the return of equity is used to compare one company to another similar type of a company, that results in a more meaningful, more efficient, and more simple way of comparison. In corporate finance, the return on equity is a measure of the profitability of the business or organization in terms of equity. Return of equity is a measure of how smartly a company or organization uses its capital for investments to generate earnings growth that leads to profit for such an organization. Return of equity is a profitability ratio from the investor’s point of view, not from the company’s point of view.
In Return on Equity formula, net income is taken from the income statement of the company: Total sum of financial activities for that particular period of a time. Shareholders’ equity is calculated from the balance sheet of a company. Shareholder’s equity is also called shareholder’s fund. Shareholder fund comprises reserves generated by the company in the past from its operation.
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Calculation of Average shareholder equity can be done by adding equity at the very beginning of the period of a time to equity and at the end of the period of a time and divide it by 2. If investors with willing to calculate a more accurate equity average, they can use the balance sheet quarterly.
Examples of Return on Equity Formula
Suppose there is a company with the name XYZ company and has an annual net income of $2,000,000 and average shareholders’ equity of $15,000,000.
This company’s Return of equity can be calculated by division of net income and average shareholder’s equity.
- Retrun on Equity = (Net Income)/(Shareholder’s Equity)
- Retrun on Equity = 2,000,000/15,000,000
- Retrun on Equity = 13.33 %
Return of equity is 13.33%.
Let’s imagine ABC Company generated $40 million in its net income in the year 2017. If Company ABC’s shareholders’ equity equaled $80 million in the same year, then using the formula of Return of Equity, That is a division of Net income ($40millions) by Average Shareholders’ equity ($80millions), then we can easily get Company ABC’s Return of equity as explaining follows:
- Retrun on Equity = (Net Income)/(Shareholder’s Equity)
- Return on Equity = $40,000,000/$80,000,000
- Return on Equity = 50%
This Proves that Company ABC generated a profit of $0.50 for every $1 of shareholders’ equity in the year 2017 and giving the stock and Return of equity of 50%
Explanation
Return of equity Formula can be easily understood by the above examples, as we have discussed earlier.
In the above example, Company ABC has generated a 50% return on equity & company XYZ has generated a 13.33 % return on equity. This indicates that Company ABC generated a profit of $0.50 for every $1 of shareholders’ equity, and company XYZ has generated $0.13 for every $1 of shareholder’s equity.
This clearly shows that investors invested in company ABC would have earned more money in terms of percentage investments.
Significance and Use of Return on Equity Formula
When a firm has a low Return on equity, it means that the firm has not used the amount invested by shareholders efficiently. It reflects that the company’s management is not in a state to provide investors with substantial returns on their investments. Equity analysts or investors feel if a firm’s return on equity is less than 13-14 percent, it is not a good firm to invest in. Firms with a return on equity of 20 percent or above are considered good investments opportunity. Analyst cautions investors not to consider companies that have a low or negative return on equity.
Return on equity is one of the most important ways of analyzing management effectiveness and efficiency. Return on equity is often used for the return of a market by comparing a company to its competitors in markets in the same industry. The use of the Return on equity formula plays an important role when comparing firms of the same industry and sectors as well. Return on equity has the ability to calculate at different periods of time to compare its changes in its values over time. Investors can track changes in management’s performance by comparing the changes in Return on equity’s growth rate from quarter to quarter or year to year.
Return on Capital Employed (RoCE) is another way of profitability performance measure. It is an important financial ratio that measures a firm’s overall profitability (both of equity holders and debt) and indicates the efficiency with which its capital (again, both debt and equity) is employed. “A company which had high debt should be analyzed using return on capital employed whereas a company with less debt should be analyzed using return on equity”
Return on Equity Formula Calculator
You can use the following Return on Equity Calculator
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Return on Equity Formula in Excel (With Excel Template)
Here we will do the same example of the Return on Equity formula in Excel. It is very easy and simple. You need to provide the two inputs i.e. Net Income and Shareholder’s Equity
You can easily calculate the Return on Equity using the Formula in the template provided.
We Calculate Return on Equity using Formula
Also Read: Tuesday Tools – Private Equity
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