Return On Equity (ROE) – Definition, Formula And Example

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Return on Equity (ROE) –

Return On Equity is a profitability ratio which helps to measure the profitability of a company. ROE tells us about how company managing and generating shareholders’ value. ROE is calculated by dividing Net Income by the Shareholders equity.

ROE simply means how many rupees of profit the company is generating for each rupee of equity.

Return on Equity

Return On Equity = Net Income / Average Shareholders’ Equity

ROE is a financial ratio used for evaluating investment returns. ROE can be used to identify profitable businesses by comparing with peers or in between same industry.

Lets take examples,

Net Income is available in Income Statement and Shareholders’ Equity is available in Balance Sheet. Net Income is a profit that company earns after deducting Interest, Tax, Costs and all. Shareholders’ equity will be mentioned in Liability side of balance sheet.

From above examples, we can see

Net Income of company A is Rs 100cr and Shareholders’ Equity is Rs 500cr, so now we can calculate ROE of company A,

ROE = Net Income / Shareholders’ Equity

ROE = Rs 100cr / Rs 500cr

ROE = 20%

Also Net Income of company B is Rs 60cr and Shareholders’ Equity is Rs 200cr, So now we can calculate ROE of company B,

ROE = Net Income / Shareholders’ Equity

ROE = Rs 60cr / Rs 200cr

ROE = 30%

From above example, we can say that company B is more profitable in terms of ROE than company A.

Now if we observe carefully we haven’t mentioned the debt of both companies because it is not require for ROE calculation. This is the drawback of ROE.

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