How to determine return on equity

Relative indicators of profitability characterize the economic efficiency of the use of a resource. The main quantity involved in the calculations of each of them is the amount of net profit. For example, to determine the profitability of capital, you need to calculate the ratio of its value to the value of equity, applied or borrowed capital.

You will need

- company balance.

Instruction manual

1

The company's capital consists of cash invested by the founders and third-party investments. For owners and investors, the most interesting is the receipt of dividends. Thus, two concepts can be divided: the profit of the company itself, i.e. income from sales of products, and profits of capital participants.

2

To calculate how effective investments can be, you need to determine the profitability of capital. There are several similar indicators, in the international notation they are presented as ROE, ROCE and ROIC in the initial letters of English words. Despite some differences, the basis for calculating each of them is the amount of net profit.

3

Equity is a combination of cash and tangible assets intended for the implementation of the main business activities of an enterprise. When they talk about the market value of the whole company, they mean exactly this value. To determine the return on equity, i.e. ROE (Return on equity) indicator, use the formula: ROE = PE / SK * 100%, where PE is net profit, SK is the average annual value of equity.

4

The positive dynamics of equity characterizes the ability of the enterprise to maintain financial equilibrium only at the expense of domestic funds. And in addition, to effectively invest part of the net profit remaining after covering all types of costs that make up the cost of sales. Otherwise, you should resort to the help of third-party investors.

5

The ROIC indicator (Return on invested capital) is calculated according to a similar scheme, however, the denominator contains a value in excess of equity by the amount of external investment. Keep in mind that only investments directly in the main activity are taken into account, i.e. in the production of goods or services. This also applies to net profit, which is considered only from the sale of these products: ROIC = PE / IR * 100%, where IR is the average annual total value of equity and borrowed capital.

6

If you need to evaluate the attractiveness of a project for potential investors, use the indicator of applied capital ROСE (Return on capital employed): ROСE = (PE - CI) / IK * 100%, where CI - dividends to investors according to the results of the financial period. that in the absence of borrowed capital, the indicator ROSE is equal to ROE.

note

The average annual value of capital is calculated according to the balance sheet as half the amount of net assets at the beginning and end of the reporting period.

return on equity is defined as