The formula for determining the return on equity. ROE is the essence of business. What is Return on Equity
In the article, we will review one of the indicators of the profitability of an enterprise - this is return on total capital. We will give a formula for calculating the financial indicator according to the balance sheet, which you can use in the main indicators of the business plan, and also consider its economic meaning in financial analysis.
is an indicator of the effectiveness of the use of capital of the enterprise. The total capital includes both current and non-current assets. Their profitability shows the profitability of the total capital of the enterprise in terms of economic activity.
The financial indicator calculated together with and reflects the return on investment.
Return on total capital is not a synonym. Although sometimes they are combined. The difference is that in the first one, as a rule, operating profit (Profit from sales) is used.
Return on total capital. Balance calculation formula
Sometimes instead of " " in the numerator of the formula, the following can be used: Revenue (p. 2100), Profit from sales (p. 200), Profit before tax (p. 2300).
The numerator is the average value of Assets. It is necessary to take the value of assets at the beginning of the period, add it to the value at the end of the period and divide by 2. The reporting period can be - a quarter, six months, a year.
One of the disadvantages of this indicator is that it reflects the efficiency of the enterprise depending on the amount of profit it received during the reporting period, but in the future, due to uncertainty, the enterprise may face a different economic situation. If this indicator decreases, it is necessary to increase it (for example, take additional credit funds) for its growth to the target levels.
Standard value of the indicator
The normative value for this indicator is not regulated and the trend of its change is estimated. The table below shows the relationship between the direction of the trend and the indicator of financial condition.
Profitability equity (Return on Equity, Return on Shareholders' Equity, ROE) shows the efficiency of using own invested funds and is calculated as a percentage. Calculated according to the formula:
ROE = Net Income / Average Shareholder's Equity
ROE = Net Income / Average Net Assets
Where, Net Income - net income before dividends on ordinary shares, but after preferred dividends are paid, as equity does not include preferred shares.
ROE can also be represented in the following form:
ROE = ROA * Financial leverage ratio
The ratio shows that the correct use of borrowed funds allows you to increase the income of shareholders due to. This effect is achieved due to the fact that the profit received from the company's activities is much higher than the loan rate. By the value of financial leverage, one can determine how the funds raised are used - for the development of production or for patching holes in the budget. Obviously, with good company management, the value of this indicator should be greater than one. On the other hand, too high leverage is also bad, as it can be associated with high risk, as it indicates a high leverage in the asset structure. The higher this proportion, the more likely it is that the company will be left without net profit at all if it suddenly encounters any even minor difficulties.
A special approach to calculating the indicator is the use of , which breaks ROE into components that allow you to better understand the result:
ROE (Dupon formula) = (Net income / Revenue) * (Revenue / Assets) * (Assets / Equity)
ROE (Dupon formula) = Net profit margin * Asset turnover * Financial leverage
AT Russian system accounting the formula for the return on equity ratio takes the form:
ROE = Net Income / Average Annual Cost of Equity * 100%
ROE = line 2400 / ((line 1300 + line 1530) at the beginning of the period + (line 1300 + line 1530) at the end of the period) / 2 * 100%
ROE = Net Income * (365/Number of Days in Period) / Average Annual Cost of Equity * 100%
According to many economists-analysts, when calculating the coefficient, it is advisable to use the net profit indicator. This is due to the fact that the return on equity characterizes the level of profit that owners receive per unit of invested capital.
The indicator characterizes the efficiency of using the company's own sources of financing and shows how much net profit the company earns from 1 ruble of its own funds.
ROE allows you to determine the effectiveness of the use of capital invested by the owners, and compare this indicator with the possible income from investing these funds in other activities.
By the way, in world practice, the ROE indicator is used as one of the main indicators of the competitiveness of banks.
Return on equity is a ratio equal to the ratio of net income to the total cost of capital of the organization. This indicator is key for large ones, since it is the analysis of return on capital that allows you to assess how efficiently the funds are invested. Owners invest resources in the statutory fund and for this they regularly receive a part of the company's profit, and the return on capital allows you to calculate the income received per unit of invested funds. To calculate equity, information from financial statements is used (in particular,).
Return on equity (formula)
Return on equity is net income divided by equity and multiplied by 100 (to convert to a percentage).
The net income indicator is indicated on the basis of the income statement; the cost of equity is taken from the liability and, as a rule, the average value is calculated ((value at the beginning + value at the end of the reporting period) / 2).
Return on equity (Dupon formula)
A three-level analysis is carried out using the DuPont formula, which considers return on equity as the product of three basic indicators: return on sales (profit divided by revenue), asset turnover ( divided by assets) and financial leverage (the ratio of loan and equity capital).
If the enterprise has unsatisfactory indicators of return on equity, then this formula allows you to understand what specifically led to such results.
Normative values of the profitability ratio
Based on the return on equity index alone, it is impossible to give objective assessment efficiency of the company. Often, the company has a fairly large share of borrowed funds, which does not necessarily indicate negative trends. Therefore, return on equity primarily reflects the return on investment. And in order to assess how effectively the funds are invested, the rate of return is compared with others. possible ways making a profit, namely, with a rate on bank deposits.
The minimum allowable value of the return on equity ratio is calculated as the average percentage of , multiplied by the difference of one and .
Thus, in cases where the return on equity falls below this rate, it is more profitable for an investor to transfer money to a deposit or invest it in another company.
In general cases, a high rate of return indicates a high profit per unit of invested capital and is positive characteristic. However, the value of the coefficient can also increase due to a large share of loan capital in statutory fund, which, in turn, indicates financial instability and high risks. This reflects the basic law of entrepreneurial and investment activity: the greater the profit, the higher the risks.
Profitability is a fairly broad concept that can be applied to different components of any company. She can choose such synonyms as efficiency, payback or profitability. It can be applied to assets, capital, production, sales, etc. When calculating any of the performance indicators, the same questions are answered: "are resources used correctly" and "is there a benefit?" The same is indicated by the return on equity (the formula used to calculate it is presented below).
Equity and investors
Equity capital means financial resources company owner, shareholders and investors. The last group is represented by people or companies that invest in business development, in third-party firms. It is important for them to know that their investments are profitable. Depends on further cooperation and development of the company in the market.
Every company needs financial injections - both internal and external. And the situation is much more favorable when these funds are represented not by bank loans, but by investments from sponsors or owners.
How to understand whether it is worth continuing to invest in a particular company? Very simple. You just need to calculate your own capital. The formula is easy to use and transparent. It can be used for any organization based on balance sheet data.
Calculation of the indicator
What does the formula look like? Return on equity is calculated by the following calculation:
Rsk \u003d PE / SK, where:
Rsk - return on capital.
SC is the equity capital of the firm.
PE is the net profit of the enterprise.
The payback of own funds is calculated most often for a year. And all the necessary values are taken for the same period. The result obtained gives a complete picture of the activities of the enterprise and the profitability of equity capital.
Do not forget that any company can be invested not only but also borrowed. In this case, the return on equity, the calculation formula of which is given above, gives an objective estimate of the profit from each unit Money invested by investors.
If necessary, the profitability formula can be changed to obtain a result in percent. In this case, it is enough to multiply the resulting quotient by 100.
If you need to calculate the indicator for a different period (for example, less than a year), then you need a different formula. The return on equity in such cases is calculated as follows:
Rsk \u003d PE * (365 / Period in days) / ((SKnp + SKkp) / 2), where
SKnp and SKkp - equity at the beginning and end of the period, respectively.
Everything is relative
In order for investors or owners to fully appreciate the profitability of their investments, it is necessary to compare it with a similar indicator that could be obtained by financing another company. If the efficiency of the proposed investment is higher than the real one, then it may be worth switching to other companies that require investment.
The formula developed to calculate the standard value can also be used. The return on equity in this case is calculated using the average rate on bank deposits for the period (Ad) and income tax (CIT):
Krnk \u003d Sd * (1-Snp).
When comparing the two indicators, it will immediately become clear how well the company is doing. But for the full picture, it is necessary to conduct an analysis of the effectiveness of equity over several years, so that it is possible to more accurately determine the temporary or permanent decline in profitability.
It is also necessary to take into account the degree of development of the company. If some innovations were introduced at the end of the period (for example, the replacement of equipment with more modern ones), then it is quite natural that there will be some decrease in profits. But in this case, profitability will certainly return to its previous level - and possibly become higher - in the shortest possible time.
About norms
Each indicator has its own norm, including the efficiency of equity capital. If you focus on (for example, such as England and the USA), then the profitability should be in the range of 10-12%. For developing countries whose economies are prone to inflation, this percentage should be much higher.
You need to know that it is not always necessary to rely on the return on equity, the formula for calculating which is presented at the beginning. The value may turn out to be too high, as the indicator is influenced by others. financial leverage. One of them is the value For such cases exists. It allows you to more accurately calculate the profitability and the influence of certain factors on it.
Eventually
Each owner and investor should be aware of the considered formula. Return on equity is a good assistant in any line of business. It is the calculations that will tell you when and where to invest your funds, as well as the right moment for their withdrawal. This is very important information in the investment world.
For owners and managers, this indicator gives a clear picture of the direction of activity. The results obtained can suggest how exactly to continue doing business: along the same path or change it radically. And the adoption of such decisions will ensure an increase in profits and greater stability in the market.
Material from the site
What is Return on Equity
return on equity (ROE), also used the term "Return on equity") - a financial ratio that shows the return on shareholders' investment in terms of accounting profit. This method accounting estimates similar to return on investment (ROI).
This relative performance indicator is expressed in the formula:
Divide the net profit received for the period by the equity of the organization.
The amount of net profit is taken for the financial year, excluding dividends paid on ordinary shares, but taking into account dividends paid on preferred shares (if any). Share capital taken excluding preferred shares.
Benefits of ROE
The financial indicator of return ROE is important for investors or business owners, since it can be used to understand how efficiently the capital invested in the business was used, how efficiently the company uses its assets to make a profit. This indicator characterizes the efficiency of using not the entire capital (or assets) of the organization, but only that part of it that belongs to the owners of the enterprise.
However, Return on Equity is an unreliable measure of a company's value, as it is believed to overestimate economic value. There are at least five factors:
1. Duration of the project. The longer, the greater the overestimation.
2. Capitalization policy. The smaller the share of capitalized total investments, the greater the overestimation.
3. Depreciation rate. Uneven cushioning results in a higher ROE.
4. The delay between investment costs and return from them through cash inflows. The larger the gap in time, the higher the degree of overestimation.
5. Growth rates of new investments. Fast growing companies have lower Return on Equity.
