What is ROE with example

 

ROE stands for "Return on Equity," and it's a financial ratio that measures a company's profitability by evaluating how effectively it generates profit from the shareholders' equity invested in the company. In other words, ROE indicates how efficiently a company utilizes the funds invested by its shareholders to generate earnings.

The formula for calculating Return on Equity (ROE) is:

$ROE = \frac{Net\ Income}{Shareholders'\ Equity} \times 100$

Where:

• Net Income: This is the company's total earnings after all expenses, taxes, and interest have been deducted.
• Shareholders' Equity: This is the residual interest in the assets of the company after deducting liabilities. It represents the amount of capital that the shareholders have invested in the company.

ROE is typically expressed as a percentage. A higher ROE suggests that a company is generating more profit from the equity invested by shareholders, indicating better financial performance and efficiency.

Here's an example to illustrate ROE:

Let's say Company ABC and Company XYZ are both in the same industry. They both have net incomes of $1 million. However, Company ABC has shareholders' equity of $5 million, while Company XYZ has shareholders' equity of $10 million.

For Company ABC: $ROE_{ABC} = \frac{1,000,000}{5,000,000} \times 100 = 20\%$

For Company XYZ: $ROE_{XYZ} = \frac{1,000,000}{10,000,000} \times 100 = 10\%$

In this example, Company ABC has a higher ROE of 20%, indicating that it is more efficient in generating profit from the equity invested by shareholders compared to Company XYZ, which has an ROE of 10%.

Remember that ROE should be considered alongside other financial metrics and industry benchmarks to get a comprehensive view of a company's financial health and performance.