Return on equity (ROE) is considered a measure of a company’s profitability and how efficient it is in generating profits. Return on equity, also known as return on shareholder funds. In simple terms, we can understand that ROE reflects the profitability of a company by measuring how much shareholders earn for their investment in the company. The higher the percentage, the more efficiently the equity base has been utilized, indicating better returns to investors.
Companies listed in the stock market release their results every quarter, which gives information about their financial position. Along with this, market experts also take the help of some special formulas based on these results, through which they get an idea of the future move of a particular company. One such formula is Return on equity ROE. It shows how well a company has used its shareholders’ money. One can calculate a company’s ROE by dividing the company’s net income by the total shareholder’s equity which is represented by a percentage.
Return on Equity (ROE) calculation formula :
The return on equity formula is as follows :
ROE= Net Income (Revenue-Expenses, Tax, Interest and other Expenses)/ Shareholders Equity
Net Income: Net income is the amount of revenue, net of expenses, Taxes, interest, and other expenses that a company generates for a certain period. The net income of companies is easily available in the company’s income statement, which they publish every quarter. Some financial analysts look at a company’s net income over the last 12 months for ROE calculations.
Shareholders Equity: Shareholders’ equity refers to the average equity available to the shareholders of the business. It is defined as the net worth of a company that will be returned to its shareholders after the company liquidates itself and pays off its debts.
Significance of Return on Equity (ROE) :
- Return on equity is an essential way to measure how profitable a company has been.
- ROE is considered a measure of a company’s profitability and how efficient it is in generating profits.
- The higher the percentage, the more efficiently the equity base has been utilized, indicating better returns to investors.
- With this, you can analyze the financial growth of the company and also know whether the company is making a profit year on year or not.
- ROE is only used to determine the financial performance of companies in the same sector, it cannot be used for companies in different sectors.
Can a company’s ROE be negative Value?
The ROE value of a company can also be negative, such companies are not giving any returns (Zero Return). If a company’s liabilities currently exceed its assets then it leads to negative shareholder equity which results in a negative ROE value.
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