Return on share capital formula. ROE is the essence of business. Return on equity - meaning
Return on equity- an important indicator of financial analysis. What he talks about and how it is considered, you will learn from our article.
What does return on equity show?
Return on equity, like other profitability indicators, indicates the efficiency of a business. More precisely, about the efficiency with which the owners’ money invested in the company’s capital works. To put it simply, profitability helps to understand how many kopecks of profit each ruble of its equity capital brings to a company.
Return on equity can give an idea to the investor or its specialists how successfully the company manages to maintain the return on capital at the proper level and thereby determine the degree of its attractiveness to investors.
The system of indicators has a similar indicator - return on assets ( cm. ). However, in contrast to it, return on equity allows us to judge precisely the work of the net equity capital of the enterprise. At the same time, the funds raised and spent on the acquisition of property may also interfere with the return on assets.
So how is profitability calculated?
How to find return on equity ratio
Profitability is always the ratio of profit to the object whose return needs to be assessed. In this case, we are looking at equity. This means that we will divide the profit into it.
IN financial analysis Return on equity is usually denoted using the ROE coefficient (short for return on equity). We use this notation, and then the formula for calculating the indicator may look like this:
ROE = Pr / SK × 100,
Pr - net profit (the return on equity indicator is calculated only based on net profit).
SK - equity capital. To make the calculation more informative, the average SC indicator is taken. The easiest way to calculate it is to add the data at the beginning and end of the period and divide the result by 2.
Return on equity is a ratio that is relative in nature; it is usually expressed as a percentage.
Factor analysis of return on equity
Sometimes another formula is used for calculation - the so-called Dupont formula. It looks like this:
ROE = (Pr / Vyr) × (Vyr / Act) × (Act / SK),
where: ROE is the required profitability;
Pr - net profit;
Vyr - revenue;
Act - assets;
SK - equity capital.
This is factor analysis of profitability.
Return on equity - balance sheet formula
This indicator can be found not only by calculation, but from reporting documents. So, there is a simple answer to the question of how to find equity from the balance sheet.
To determine return on equity capital, information contained in the balance sheet lines (Form 1) and in the income statement is used. financial results(Form 2).
The balance formula will look like this:
ROE = Line 2400 of Form 2 / Line 1300 of Form 1 × 100.
For more information on the balance sheet, see the article , and about form 2 - .
Profitability or return on equity - standard value
The main criterion used in assessing return on equity is to compare this indicator with the return on investment in other areas of business, for example, in securities of other companies.
The standard value of ROE is widely used to assess the effectiveness of investments. Typically, investors focus on values from 10 to 12%, which are typical for businesses in developed countries. If inflation in the state is high, then the return on capital increases accordingly. For the Russian economy, 20 percent is considered the norm.
If the indicator goes negative, this is already an alarming signal and an incentive to increase the return on equity. But a significant excess over the standard value is also an unfavorable situation, since investment risks increase.
Results
Profitability or return on equity is important for assessing the performance of an enterprise. To find this indicator, several formulas are used, data for which is taken from the lines of the balance sheet and income statement.
Return on equity (ROE, return on equity) is a financial indicator expressing profit on share capital. Close to the indicator return on investment ROI.
The indicator shows the ratio of net profit for the period to the equity capital of the enterprise.
Formula for calculating ROE ratio
Net income does not include dividends on common stock, and equity does not include preferred stock.ROE = PE / SK
, Where:
PE - net profit;
SK - equity capital.
Benefits of ROE
ROE ratio is one of the most important indicators for investors, top managers, and owners of an enterprise, as it shows the effectiveness of their own investments (with the exception of borrowed funds).Disadvantages of ROE
Analysts question the reliability of the ROE indicator, believing that return on equity ratio overestimates the company's value. There are 5 factors that make ROE not completely reliable:- Long project duration - the longer the analysis period, the higher the ROE.
- A small share of total investments on the balance sheet. The smaller the share the higher the ROE.
- Uneven depreciation. The more uneven the depreciation is during the reporting period, the higher the ROE.
- Slow return on investment. The slower the project pays off, the higher the ROE.
- Growth rates and investment rates. The younger the company, the faster the growth of the balance sheet, the lower the ROE.
Standard ROE value
ROE norm for developed countries it is 10-12%. For developing countries with high inflation rates - many times more. On average, 20%. Roughly speaking, return on equity is the rate at which a company attracts investment.Analysis of return on equity ratio by division of the company (by business area) can clearly show the effectiveness of investing funds in one or another area of business, for the production of one or another product or service. Also for the investor ROE comparison for two companies in which he has an interest, can show the most effective in terms of return.
When assessing normative value ROE It's worth considering replacement costs. If on at the moment securities with a low risk indicator are available, yielding 16% per annum, and the main line of business gives an ROE of 9%, then the ROE goal should be set higher, or the business as a whole should be reviewed.
Equity capital characterizes the return on shareholders' investments in terms of the profit received by the company. This coefficient can be abbreviated ROE (return of investment) and have a different name - to joint stock. The calculation is made using the formula:
Net income includes dividends paid on preferred shares but excludes those paid on common shares securities. The capital value does not take into account preferred shares.
How is return on equity useful?
It makes it possible to judge how effectively it is used. It is important to consider: the ratio demonstrates the efficiency of only that part of the capital that belongs to the owners of the company. The ROE indicator is considered not the most reliable indicator of the financial condition of an organization - it is generally believed that it overestimates the value of the company.
There are five main ways to interpret meaning:
1. Depreciation. A high ROE indicates uneven depreciation.
2. Growth rate. Companies that are growing rapidly have low ROE.
3. Project duration. Long-term projects are characterized by a high coefficient value.
4. Time gap. The longer the time period between investment expenses and the return on them, the higher the ROE.
Return on equity is a strategically important indicator for an investor. From the article you will learn what formula to calculate the ratio and what ROE values are considered normal, and you will also find a ready-made Excel model.
What does return on equity mean?
Return on equity is a ratio that shows the amount of profit that an enterprise will receive on. Another name for the term is return on equity ratio.
An important difference between this indicator and “return on assets” is that it demonstrates the efficiency of using not the entire capital of the enterprise, but that part of it that the owners invested.
Return on Equity: Formula
ROE = (Net profit for the period / Average equity for the period) x 100%
How to conduct factor analysis of return on equity in Excel:
Return on equity on balance sheet
To calculate the return on equity ratio based on the organization’s balance sheet, the following formula is used:
ROE = (line 2400 Form 2 / line 1300 Form 1) x 100%
The data for the formula is taken from Form 2 of the Profit and Loss Statement and Form 1 of the Balance Sheet in the new edition.
Return on equity ratio according to IFRS
According to IFRS the formula will look like this:
RSC= ROE =Net Income After Tax / Shareholder’s Equity,
where Net Income After Tax is net profit after taxes,
Shareholder's Equity - share capital.
Excel model for calculating and analyzing return on equity
Download the ready-made Excel model prepared by experts.
Normal ROE value
ROE characterizes the profit that the owner will receive from a ruble investment in the enterprise. The normal level of return on equity in the West is considered to be 10-12%. For Russia (as an inflationary economy), the ROE value should be higher - some sources consider 20% to be an acceptable figure.
The minimum acceptable level of return for an investor is the average rate on bank deposits. According to data at the end of April 2019, in Russia this figure is 7.5%.
In general, experts advise comparing this ratio with the return that can be obtained if you invest in another project (or assets/securities). That is, the higher the value of the indicator in comparison with the alternative, the more reasons there are to invest money in the enterprise.
Nuance: a business owner, making a decision about the fate of his company based on ROE, must understand that the average amount of equity capital is not equal to market value companies.
The return on equity ratio shows how profitable the investment in the business was. If you compare it with industry averages, as well as the return on investments in stocks and bonds, bank deposits and mutual funds, you can determine whether the company’s owners should transfer funds to other areas of investment. For the calculation, you need to use information from forms No. 1 and No. 2: net profit (form 2), equity capital and reserves (form 1) and deferred income (form 1). The normal value of the indicator for Russian practice is 20% (0.2).
Any business owner wants to know how effectively the money he has invested in the company is working. Indicators of net profit, annual revenue, and even will not be able to provide the investor with objective information about how correct the investment he made. Only the return on equity ratio can show whether it is worth continuing the business or whether it is better to transfer funds to other areas of investment.
Return On Equity Ratio (ROE, KRSC)- this is one of the main financial ratios, which is calculated as the ratio of a company’s net profit to the average annual value of its equity capital. It characterizes the profitability of a business for its owners who have invested their capital in the business.
Reference! Despite the obvious similarities with a company's return on assets (ROA), there is a clear difference between these two indicators: ROA looks at the efficiency of using the company's entire capital (including borrowed funds), and ROE shows how effectively the part of the capital that belongs to owners is used .
The return on equity indicator does not simply reflect the operating efficiency of the company, it acts as a significant criterion for the quality of investments for business owners (shareholders).
Important point! Unlike the indicators ROA (return on assets) and ROIC (return on invested capital), it is not adjusted to the total amount of interest on loans, since it is in no way related to borrowed funds.
The return on equity ratio (ROC) literally characterizes how much profit the enterprise brought for each unit of equity invested in it.
Formula for calculating the indicator
The basis for calculating the SC coefficient is balance sheet enterprise (form 1) and profit and loss statement (form 2). For this purpose, the following articles are used:
- Net profit (item 2400).
- Own capital and reserves (Article 1300).
- Future income (Article 1530).
Important point! In order for the result of calculating the coefficient to be as accurate as possible, the value of Art. 1300 is taken into account at the beginning and end of the year.
KRSK = PE / ((SKng + SKkg) / 2), where:
PE - net profit or loss of the company;
SKng - own funds at the beginning of the year;
SKkg - own funds at the end of the year.
For convenience, the above formula for calculating the return on equity ratio can be expressed in the articles financial statements:
KRSK = Art. 2400 / ((st. 1300 ng + st. 1300 kg + st. 1530 ng + st. 1530 kg) / 2)
If KRSC is calculated based on IFRS data, then the appropriate formula can be used:
ROE =NIAT / ((SE ng - SE kg) / 2), where:
NIAT - Net Income After Tax - net profit after taxes;
SE - Shareholder's Equity - share capital.
The calculation process is shown in detail in the video.
Normal value of efficiency of use of equity capital
Return On Equity shows owners how their invested funds work: how much net profit each unit of the insurance company brought. In this situation, the following statements can be made regarding the ROE indicator:
- The higher the coefficient, the higher the return on investment in business.
- If the calculation result turns out to be close to zero, then the feasibility of investing in enterprises is very doubtful.
Important point! Some domestic experts believe that in Russian economy The standard ROE value is 20% (0.2). However, for analysis it is still better to compare the calculation results with industry averages.
The resulting profitability value is usually compared with average profitability in the industry, the average interest rate in the economy, and then - with the return on investments in stocks, bonds, bank deposits, etc.
Important point! An excessively high value of KRSK may indicate a decrease in the financial stability of the enterprise: the higher the return on investment, the greater the level of risk.
Examples of coefficient calculation
In order to delve into the process of calculating the profitability ratio of the insurance company in detail, it is worth citing practical examples determining this indicator and assessing its values.
Conclusion! The profitability indicator of the insurance company for Yug Rusi - Zolotaya Semechka LLC, the brainchild of a famous millionaire entrepreneur in Russia, is close to the standard (20%). Therefore, investments in the business of the owners are completely justified. During 2016-2017, the indicator was relatively stable.
Conclusion! KRSK for Bunge Limited (BG) LLC, which is engaged in production in Russia vegetable oil under the Oleina brand is below the standard value, which indicates insufficiently efficient use of invested equity capital. Although there is an improvement in the indicator in 2017 compared to 2016.
If we consider two enterprises of the same industry (production and sale of vegetable oil), then it can be noted that Yug Rusi - Zolotaya Semechka LLC uses the owners’ funds more efficiently in its activities: every ruble invested in production brings about 20 kopecks of profit.
The company “Bunge Limited (BG)” should analyze the state of affairs in the company, carry out reforms, or even transfer capital to another industry.
Calculation of the profitability ratio of the insurance company in the Excel spreadsheet editor is given in.
