Return on equity formula. ROE is the heart of the business
Profitability equity
(ROE, return on equity) is a financial indicator that expresses the return on equity. Close to indicator return on investment ROI.
The indicator shows the ratio of net profit for the period to the equity capital of the enterprise.
ROE formula
Net income excludes dividends on ordinary shares, and equity excludes preference shares.ROE = PE / SK
, where:
PE - net profit;
SC - equity.
ROE Benefits
ROE ratio is one of the most important indicators for investors, top managers, owners of the enterprise, as it shows the effectiveness of their own investments (excluding borrowed funds).Disadvantages of ROE
Analysts question the reliability of the ROE indicator, believing that return on equity ratio overestimates the value of the company. There are 5 factors that make ROE not completely reliable:- High project duration - the longer the analysis period, the higher the ROE.
- A small share of total investment on the balance sheet. The smaller the share the higher the ROE.
- Irregular depreciation. The more uneven in reporting period depreciation, 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 balance sheet growth, the lower the ROE.
Guideline ROE
ROE norm for developed countries is 10-12%. For developing countries with a high rate of inflation - many times more. On average, 20%. Roughly speaking, the return on equity is the rate at which the company attracts investments.Analysis of the return on equity ratio by divisions of the company (by business areas) can clearly show the effectiveness of investing in a particular line of business, for the production of a particular product or service. Also for investors ROE comparison for two companies in which he has an interest, he can show the most effective in terms of returns.
When evaluating standard ROE value replacement cost should be taken into account. If currently available securities with a low risk indicator, bringing 16% per annum, and the main line of business gives a ROE of 9%, then the goal for ROE should be set higher, or the business as a whole should be reviewed.
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 accounting valuation method is 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 is 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. Delay between investment costs and return from them through inflow Money. 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.
Return on equity is one of the most important business performance indicators. Any investor, before investing his finances in an enterprise, analyzes this parameter. It shows how competently the assets belonging to the owners and investors are used.
An example of the equity formula in Excel can be downloaded.
The return on equity ratio reflects the value of the ratio of net profit to the company's own funds. It is clear that such a calculation makes sense when the organization has positive assets that are not burdened with borrowing restrictions.
Assessment of return on equity
The following indicators affect the return on equity:
- efficiency of operating activity (net profit from sales);
- return of all assets of the organization;
- the ratio of own and borrowed funds.
How to evaluate the return of a business by looking at the profitability ratio?
- Compare it with alternative returns. How much will a businessman get if he invests his money in another business? For example, he will attribute the funds to a bank deposit, which will bring 10% per annum. And the profitability ratio of the existing enterprise is only 5%. It is clear that it is inexpedient to develop such a company.
- Compare the indicator with the norms that have historically developed in the region. Thus, the average profitability of companies in England and the US is 10-12%. In countries with stable economies, a coefficient in the range of 12-15% is desirable. For Russia - 20%. In each particular state, the values of the indicator are influenced by many factors (inflation, industrial development, macroeconomic risks, etc.).
- High profitability does not always mean high financial results. The higher the ratio, the better. But only when a large proportion of investments are the company's own funds. If borrowed funds predominate, the organization's solvency is at risk.
Thus, a huge debt burden is dangerous for financial stability firms. Calculating the return on equity is useful if the company has this very capital. The predominance of borrowed funds in the calculation gives a negative indicator, which is practically not suitable for analyzing the return on business.
Although it is impossible to be categorical about the profitability ratio. Its use in analysis has some limitations. The real income of the owner or investor does not depend on assets, but on operational efficiency (sales). Based on a single indicator of return on own capital investments, it is difficult to assess the productivity of a firm.
Most companies are heavily leveraged. The same banks exist only on borrowed funds (attracted deposits). And their net assets serve only as a guarantor of financial stability.
Whatever it was, but the profitability ratio illustrates the company's income earned for investors and owners.
How to calculate the return on equity?
The company's return on equity shows the amount of profit that the company will receive per unit of cost. own funds. For a potential investor, the value of this indicator determines:
- The profitability ratio gives an idea of how wisely the invested capital was used.
- Owners invest their funds, forming the authorized capital of the enterprise. In return, they are entitled to a percentage of the profits.
- The return on equity reflects the amount of profit that the investor will receive from each ruble advanced to the company.
Return on equity formula for calculating the balance sheet
The calculation is the ratio of net profit for the year to the company's own funds for the same period. The data is taken from the Profit and Loss Statement and the Balance Sheet. If you need to find the coefficient in percent, then the result is multiplied by 100.
The formula for return on equity based on net profit:
RSK \u003d PE / SK (avg.) * 100, where
- RSK - return on equity,
- PE - net profit for the billing period,
- SC (cf.) - the average size investments for the same billing period.
Formula calculation example. Firm "A" has own funds in the amount of 100 million rubles. Net profit for the reporting year amounted to 400 million. RSK \u003d 100 million / 400 million * 100 \u003d 25%.
An investor can compare several companies in order to decide where it is more profitable to invest money.
Example. Firm "A" and "B" have the same amount of equity, 100 million rubles. The net profit of enterprise "A" is 400 million, and that of enterprise "B" is 650 million. Substitute the data into the formula. We get that the profitability ratio of the company "A" - 25%, "B" - 15%. The profitability of the first organization turned out to be higher at the expense of its own funds, and not at the expense of revenue (net profit). After all, both enterprises entered the business with the same amount of capital investment. But firm "B" worked better.
Accurate calculation of profitability
To obtain more accurate data, it makes sense to divide the analyzed period into two: calculate income at the beginning and at the end of a certain period of time.
The calculation is:
RSK \u003d PE * 365 (days in the year of interest) / ((SKng + SKkg) / 2), where
- SKng - equity at the beginning of the year;
- SKkg - the amount of own funds at the end of the reporting year.
If the indicator needs to be expressed as a percentage, then the result, respectively, is multiplied by 100.
What numbers are taken from accounting forms?
To calculate net profit (from form No. 2, “Profit and Loss Statement”; line numbers and their names are indicated):
- 2110 "Revenue";
- 2320 Interest receivable;
- 2310 "Income from participation in other organizations";
- 2340 "Other income".
To calculate the amount of equity capital (from form N1, "Balance sheet"):
- 1300 “Total for the section “Capital and reserves”” (data at the beginning of the period plus data at the end of the period);
- 1530 "Deferred income" (data at the beginning plus data at the end of the reporting period).
Calculation of the standard rate of return
How to understand that it makes sense to invest in a business? Return on equity shows the normative value. One way is to compare profitability with other options for advance money (investing in shares of other firms, buying bonds, etc.). The normative level of profitability is considered to be interest on deposits in banks. This is a certain minimum, a certain boundary for determining the return of a business.
The formula for calculating the minimum profitability ratio:
RSK (n) \u003d Std * (1 - Stnp), where
- RSK (n) - the standard level of return on equity (relative value);
- Std - deposit rate (average for the reporting year);
- Stnp - income tax rate (for the reporting period).
If, as a result of calculations, the rate of return on invested own financial resources turned out to be less than RSK (n) or received a negative value, then it is unprofitable for investors to invest in this company. The final decision is made after analyzing the profitability over the past few years.
When analyzing the performance of a company, profitability indicators are often used. Usually, the following 4 main types of profitability ratios are calculated: return on sales, return on total capital, return on equity, and EBITDA return. Profitability of sales shows what share, net profit takes in total sales. Accordingly, the formula for calculating the profitability of sales is as follows:
Return on sales = net profit / sales volume (revenue)
It is clear that the higher this indicator, the better. However, there will be significant differences in its values when analyzing companies. various industries. Comparison of profitability of sales should be carried out for peer companies. The reasons, for example, for an increase in this indicator, may be as follows: either the numerator of our ratio increases (ie profit), or the denominator decreases (sales volume falls), or the first and second simultaneously. Profit can change for various reasons, not necessarily due to an increase in the price of goods or services.
As for the decline in sales, it is important to understand the reasons why this happens. Webinars from the forex broker Gerchik & Co will help you with this. If sales decrease against the backdrop of an increase in price, then this development of events can be regarded as normal. If sales are falling due to a drop in interest in the company's products, then this situation should alert investors. At the same time, there may even be an increase in the profitability of sales due to a short-term increase in profits (profit is a very volatile thing and depends on many factors, such as cost reduction, a sharp decrease in depreciation and other accounting tricks). Summarizing the above, we can say that the analysis of profitability of sales is a very vague task, but with all the shortcomings of this method of analysis, it allows you to get an initial picture of the company's profitability and compare peer companies.
Return on total capital gives us an idea of how effectively the company manages all its capital - equity and borrowed. The return on total capital is calculated using the formula:
Return on total capital = net profit / total capital.
By the amount this indicator the amount of borrowed funds and the cost of servicing the debt have a strong influence. The higher the share of borrowed funds under which the company raises funds and the higher the percentage, the lower the net profit and, accordingly, the lower the return on total capital. This indicator is very important in the analysis of business performance. According to the profitability of all capital, you can compare not only companies in different industries, but also determine the most profitable industries where you should invest your money. Return on equity (share) capital demonstrates the company's success in increasing share capital or its inability to generate a sufficient level of profitability. The formula for return on equity is:
Return on equity = net income / equity.
Return on equity is quite relative indicator, which characterizes the current turnover of the organization's income. The corresponding characteristic fully reflects the effectiveness production process enterprise as a whole, also shows the profitability of the main areas of production activity.
In the vast majority of cases, the corresponding indicators are used in the procedure financial analysis. This is due to the fact that they can more fully reflect the results of activities that have an economic focus. The level of the indicator can indicate the ratio of the results of such activities to the resources consumed in the production process.
An appropriate analysis of financial indicators shows a complete picture of the organization's performance, its ability to pay credit loans, profitability, as well as prospects for development and growth. The information helps the organization's authorized analysts rely on specific metrics to forecast and make strategic decisions for the future.
It should be noted that the profitability is quite wide variety. All types indicate the effectiveness of the functioning of the organization from different points of view. The corresponding indicators can be conditionally combined into three groups, each of which has a separate focus - , from capital and .
It is the return on capital that can fully reflect the ratio of partial income to the average price of all capital invested in the production process.
Central moments
Concept overview
Return on equity is solely an indicator financial plan. It fully characterizes the volume of profit within the assets at the disposal of the enterprise. In the process of analysis, all assets are taken into account. To calculate the profitability of the organization's activities, it is necessary to establish the volume of sales made for a certain time period.
Relevant information can be considered both for the shipment of goods and for its payment. When considering this issue, the management of organizations rely on the convenience of a specific method for determining the sales volume. After that comes the definition. Such an operation is carried out in the same way as when determining the volume from sales.
Among other things, it is imperative to take into account operating expenses, which are included in the item fixed costs for the same period of time. Tax collection is also calculated, after which the net profit indicator is determined. It is worth noting the fact that all indicators in the calculation must be adjusted to single system measurements, otherwise the process will lead to inaccurate results.
The final step is just the calculation of return on capital. To do this, net profit is divided by the assets of the organization. When calculating profitability, analysts can determine the quality of financial operations performed within the enterprise, as well as assess possible prospects.
Existing species
Practice shows that there are several types of enterprise profitability:
| Return on total capital | The total capital is a certain amount working capital organizations and assets that do not fall into the general circulation. The corresponding formula for calculation is characterized by the ratio of profit to investment. |
| Return on borrowed capital | The calculation of profitability within this framework is carried out to implement the procedure for analyzing the organization's economy. characterized by funds raised in the framework of obtaining material support or registration of credit programs. |
| Return on working capital |
|
| Return on investment capital |
|
| Return on permanent capital | A specific indicator allows the analytical team to plot the level of effectiveness of funds raised in the work of the organization in the long term. |
common data
It is worth noting immediately the fact that the higher the equity ratio, the better things are for the enterprise. However, it is important to take into account that a high level of the corresponding indicator can be obtained in cases where a certain financial leverage is used. In other words, for example, a massive share of debt capital can be used instead of equity, which, in turn, can have a rather bad effect on the company's stability.
It is recommended to start calculating the indicator under consideration only when the organization has a certain share of equity in the form net assets. If this condition is not met, then the calculation may lead to the detection of a negative value. In this case, the analysis will be quite problematic.
The following characteristics can directly affect the return on equity indicators:
- the effectiveness of the sale of manufactured products;
- return on all organizational assets;
- the ratio of borrowed and own funds.
To evaluate the returns of the production process, it is necessary to compare it with the information that can be found in the reporting documentation on alternative returns. For example, if the company's management decides to transfer part of its own funds to a bank deposit at 10% per annum, while the profitability ratio will be only 5%. In this case further development companies will become inappropriate.
It is important to remember that high profitability indicators may not in all cases indicate an increased financial return on the organization's activities. Within this framework, if the majority of the capital is occupied by borrowed funds, then the solvency of the company may become very low. Any bank in this case will refuse to provide borrowed funds.
Accordingly, large debt obligations can lead to the collapse of the enterprise. It should be noted that it is required to calculate the return on equity only in cases where such capital is available. The use of an appropriate coefficient in the analysis may have whole line restrictions.
Calculation of return on equity using the formula
In the process of analyzing the rate of return on capital, it is important to take into account certain circumstances. The profitability itself can fully reflect the current financial condition and each time decreases if the company resorts to massive investments that are directed directly to the expansion or transformation of production.
To determine the current level of costs in the framework of the functioning of the organization or the implementation of investment projects, it becomes necessary to determine the current amount of capital. The corresponding concept is understood as a certain amount of funds that must be paid without fail for the use of resources. In other words, these are the expenses of the organization aimed at servicing debt obligations.
In relative terms, the level of capital can be characterized by the relationship between maintenance costs and the amount of capital. All costs are made up of the cost of servicing own and borrowed funds.
Tsk \u003d Tsk x (Sk / capital) + Tsk x (Sk / capital)
Comparison of indicators
Comparison key indicators profitability is presented in the table below:
| ROE | ROCE | |
| Who uses the appropriate coefficient | Organization owners | Owners with investors |
| Main differences | In the process of investing, the company uses funds from its own capital | Both equity and debt capital are used through shares. In addition, there is a subtraction from net income. |
| Formula used to calculate | Net profit divided by the level of equity | Net income is divided into equity plus long-term liabilities. |
| Standard value | Maximization | |
| Scope of use | Used in any field of activity | |
| Frequency of appropriate evaluation | Every year | |
| Estimation Accuracy financial condition organizations | Less | More |
For a better understanding of the difference between the organization's profitability ratios, it is necessary to remember that if the organization does not have preferred shares, which are expressed in long-term obligations, then the values \u200b\u200bconsidered are reduced to the “equal” indicator.
Evaluation Formation
The following components can directly affect the return on equity:
- the effectiveness of the operations carried out, resulting in a net profit from the organization;
- the return on all assets directly owned by the enterprise;
- the ratio of own and borrowed funds.
The underlying nature of the return of the production process is estimated by comparing it with the data presented in the reports on opportunity returns. In accordance with the calculations, the accounting department of the enterprise may come to the conclusion that the further development of the organization will be inappropriate, and most importantly, obviously unprofitable.
A company's return on equity can indicate the amount of profit a company will earn per unit of value. own resources. For potential investors it is the value of the corresponding indicator that is decisive.
The coefficient gives a clear idea of how correctly the investment funds were used. When calculating, it is important to take into account both internal and external factors.
Business owners invest their own financial resources as part of the formation authorized capital organizations. In return, they can receive a certain percentage of the profits. In addition, the return on equity can reflect the level of profit that an investor will receive from each ruble invested in the development of an enterprise.
It is worth noting the fact that the profitability ratio primarily shows organizational income, which is directed, first of all, directly to the revenue of investors, which can be any financial institution, and owners.
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