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What Is Return On Equity?

what is return on equity

Definition of Return on Equity (ROE)

  • ROE is another method to measure the profitability of a company.
  • The ROE divides the net income of a company with the shareholder’s equity.
  • The ROE is expressed as a percentage.
  • The shareholder’s equity is the company’s assets minus the company’s debt.
  • Therefore the ROE is arguably the net return on assets.
  • The ROE, therefore, measures how effectively a company uses its assets to generate profits.
  • The ROE’s in each sector are different; therefore, its important to compare with the companies in the industry.

What is the Formula for ROE?

  • The ROE can be calculated by dividing the Net Income by the Shareholder’s Equity.

Net Income ÷ Shareholder’s Equity

  • The net income can be calculated by subtracting the Revenue by Cost of Goods Sold, Expenses, Depreciation, Amortization, Interest, and Taxes
  • The Average Shareholder’s Equity can be calculated by subtracting the Total Assets by the Total Liabilities 

ROE in Practice 

  • Opac Corporation has a revenue of $50,000,000, and its cost of goods sold is worth $35,000,000.
  • Furthermore, Opac also spends $2,500,000, on salaries, $300,000 on utilities and $120,000 on maintenance costs.
  • The depreciation is $35,000 on the assets that Opac owns. The amortization value is $20,000 and Opac currently pays $5,000,000 in interest. The tax rate is 20%.
  • The total assets are worth $150,000,000, and the total liabilities are worth $80,000,000. What is the ROE?
  • 50,000,000 – 35,000,000 – 2,500,000 – 300,000 – 120,000 – 20,000 – 5,000,000 = $7,060,000
  • 7,060,000 x 0.2 = $1,412,000
  • 7,060,000 – 1,412,000 = $5,648,000
  • Therefore the Net Income is $5,648,000
  • 15,000,000 – 8,000,000 = $7,000,000
  • 5,648,000 ÷ 7,000,000 = 0.08
  • 0.08 x 100 = 8%
  • Therefore the ROE for Opac corporation is 8%