How to calculate return on equity

Return on equity is the most important indicator of the effectiveness of an enterprise. Like other indicators of profitability, it is a relative value and determines the return on equity.

Instruction manual

1

The return on equity indicator characterizes the amount of profit that the owners of the enterprise receive on the capital invested by them. It is calculated as the ratio of the profit remaining at the disposal of the company, multiplied by 100, to the amount of equity (III section of the balance sheet). The dynamics of this indicator wags the level of stock quotes of the company and shows the quality of advanced capital management.

2

If we compare the return on equity with the level of return on assets, we can determine the effectiveness of the enterprise using financial leverage (loans and borrowings). Return on equity increases if the share of borrowed funds in the amount of generated assets increases. The difference between return on equity and return on total capital is the effect of financial leverage. In other words, this is an increase in return on equity by attracting borrowed funds (credit).

3

When analyzing the return on equity, they use such a concept as leverage. It represents the share of attracted sources of financing in the amount of assets of the enterprise. The ratio of sources of property formation will be optimal if an increase in return on equity is ensured along with an acceptable amount of financial risk.

4

Therefore, sometimes it is advisable for the organization to use borrowed funds (loans), even if the amount of equity capital of the enterprise is sufficient for the formation of property. This is due to the fact that the effect of the use of borrowed funds, expressed in the growth of return on equity, may be higher than the interest rate on the use of these funds.